QE

RBI to Print Rs 1 Lakh Crore to Keep Government Happy

After Lehman Brothers, the fourth largest investment bank on Wall Street went bust in September 2008, the Federal Reserve of the United States, the American central bank, came up with three rounds of large-scale asset purchases (LSAP). The LSAP was popularly referred to as quantitative easing or QE.

Yesterday, Shaktikanta Das, the governor of the Reserve Bank of India (RBI) announced a similar sounding GSAP or G-sec acquisition programme, where G-sec stands for government securities. India now has its own planned QE. (At the risk of deviation, it’s not just the Indian film industry which copies the Americans, our central bank also does.)

The government of India issues financial securities known as government securities or government bonds, in order to finance its fiscal deficit or the difference between what it earns and what it spends. Banks, insurance companies, non-banking finance companies, mutual funds and other financial institutions, buy these securities. Some are mandated to do so, others do it out of their own free will. 

What does GSAP entail? Like was the case with the Federal Reserve and the LSAP, the RBI will print money and buy government securities. For the first quarter of 2021-22 (April to June), the RBI has committed to buying government securities worth Rs 1 lakh crore. The first purchase under GSAP of Rs 25,000 crore will happen on April 15, later this month.

Why is this being done? Among other things, the RBI is also the debt manager for the central government. It manages government’s borrowing programme. After borrowing Rs 12.8 lakh crore in 2020-21, the government is expected to borrow another Rs 12.05 lakh crore in 2021-22. Due to the covid-pandemic and a general slowdown in tax revenues over the years, the government has had to borrow more in order to finance its expenditure and the fiscal deficit.

This information of the government having to borrow more than Rs 12 lakh crore again in 2021-22, came to light when the annual budget of the central government was presented on February 1. Due to this higher borrowing, the bond market immediately wanted a higher return from government securities.

The return (or yield to maturity as it is more popularly know) on 10-year government securities as of January 29, had stood at 5.95%. By February 22, the return had jumped to 6.2% or gone up by 25 basis points, in a matter of a few weeks. One basis point is one hundredth of a percentage. 

The yield to maturity on a security is the annual return an investor can expect when he buys a security at a particular price, on a particular day and holds on to it till its maturity.

As the latest monetary policy report of the RBI released yesterday points out: “Yields spiked following the announcement of government borrowings of  Rs12.05 lakh crore for 2021-22 and additional borrowing of Rs 80,000 crore for 2020-21.”

In May 2020, the government had announced that it would borrow a total of Rs 12 lakh crore in 2020-21. When the budget was presented, the government said that it would end up borrowing Rs 12.8 lakh crore or Rs 80,000 crore more. 

At any given point of time, the financial system can only lend a given amount of money. When the demand for money goes up, it is but natural that the return expected by the lenders will also go up. This led to the bond market demanding a higher rate of return on government securities, pushing up the yields or returns on government securities.

How did this become a bother for the government? When the returns on existing government securities go up, the RBI has to offer higher rates of interest on the fresh financial securities that it plans to issue on behalf of the government to fund the fiscal deficit. This pushes up the interest bill of the government, which the government is trying to minimise. 

Government securities are deemed to be the safest form of lending. Once returns on these securities go up, the interest rates in general across the economy tend to go up, which is not something that the RBI wants at this point of time. The hope is that lower interest rates will help the economy revive faster.

As the debt manager of the government, it’s the RBI’s job to offer the best possible deal to its main client. Hence, post the budget, the RBI got into the job quickly and to drive down returns on government securities launched an open market operation (OMO). As the monetary policy report points out: “Yields subsequently eased somewhat on the back of… the OMO purchases for an enhanced amount of Rs 20,000 crore on February 10, 2021.”

In an OMO, the RBI prints money and buys government securities from those institutions who are willing to sell them. The idea here is to pump more money into the financial system and in the process ensure that yields or returns on government securities go down.

With the GSAP, the RBI has just taken this idea forward. While the GSAP is not very different from the OMOs that the RBI carries out, it is more of an upfront commitment and clear communication from the RBI that it will do whatever it takes to ensure that yields on government securities don’t go up. Like between April and June, the RBI plans to print and pump Rs 1 lakh crore into the financial system. 

Let me make a slight deviation here. In this case, the RBI is also indirectly financing the government’s fiscal deficit. As the debt manager for the government, the RBI sells fresh securities to raise money in order to help the government finance its fiscal deficit.

These securities are bought by various financial institutions. When they do this, they have handed over money to the RBI, which credits the government’s account with it. In the process, the financial institutions as a whole have that much lesser money to lend for the long-term.

By printing money and pumping it into the financial system, the RBI ensures that the money that financial institutions have available for lending for the long-term, doesn’t really go down or doesn’t go down as much,

Hence, in that sense, the RBI is actually indirectly financing the government borrowing. (It’s just buying older bonds and not newer ones directly). A reading of business press tells me that the bond market expects more money printing by the RBI during the course of the year. One particular estimate going around is that of more than Rs 3 lakh crore. In that sense, even if the RBI prints Rs 3 lakh crore, it will indirectly finance around a fourth of the government borrowing given that it is scheduled to borrow Rs 12.05 lakh crore in 2021-22. 

Now getting back to the topic. Like in any OMO, while carrying out a GSAP operation, the RBI will print money and buy government securities. In the process, it will put money into the financial system. This will ensure that returns on government securities don’t go up. In the process, the government will end up borrowing at lower rates.

This is how the RBI plans to keeps its main customer happy. It needs to be mentioned here that with the second wave of covid spreading across the country, chances are economic recovery will take a backseat and the government will have trouble raising tax revenues like it did in 2020-21, the last financial year.

This might lead to increased borrowing on the government front. Increased borrowing without the RBI interfering will definitely lead to the bond market demanding higher returns from government securities. With the GSAP, the hope is that yields or returns on government securities will continue to remain low.

It is worth remembering that Shaktikanta Das’ three year term as the RBI Governor comes to an end later this year. Hence, at least until then, it makes sense for Das to keep Delhi happy.

Of course, the money printing leading to lower return on government securities, will also ensure that the interest you, dear reader, earn on your fixed deposits, will continue to remain low, and the real rate of interest after adjusting for the prevailing inflation, will largely be in negative territory. 

As mentioned earlier, lending to the government is deemed to be the safest form of lending. And if that lending can be carried out at low rates, the other rates will also remain low. This is the cost of the RBI trying to help the government, the corporates and the individual borrowers. It comes at the cost of savers. This is interest that the savers would have otherwise earned.

It is as if the RBI is telling the savers, don’t have your money lying around in deposits. Chase a higher return. Buy stocks. Buy bitcoin. 

If the RBI had let the interest rates find their own level, with the government borrowing more, the interest rates would have gone up and helped the savers earn a higher return on their deposits. This would have also encouraged consumption, especially among those individuals whose expenditure depends on interest income. The argument offered by economists over and over again is that lower interest rates lead to higher borrowing and faster economic recovery.

Let’s take a look at this in the case of bank lending to industry. As of February 2021, the total bank lending to industry stood Rs 27.86 lakh crore. As of February 2016, five years back, the total bank lending to industry had stood at Rs 27.45 lakh crore.

Over a period of five years, the net bank lending to industry has gone up by a minuscule Rs 40,731 crore or just 1.5%. Meanwhile, the interest rate on fresh rupee loans given by banks during the same period has fallen from 10.54% to 8.19%, a fall of 235 basis points.

So much for corporates borrowing more at lower interest rates. This is their revealed preference; the actions that they are taking and not the bullshit that they keep mouthing on TV and in the business media. Currently, the Indian corporate simply isn’t confident enough about the country’s economic future and that’s the reason for not borrowing and expanding, irrespective of the public posturing. 

Anyway, the point is not that higher interest rates are required. But the point is that if the RBI did not intervene like it has been doing, by printing money and buying bonds, slightly higher interest rates which would put the real interest rate in positive territory, would have been the order of the day. And that would have been better than the prevailing situation. A little better for the savers about whom neither the RBI nor the government seems to be bothered about.

But then as I said earlier, the government is the RBI’s main customer these days. And that’s the long and the short of it.

Federal Reserve ends money printing, but the easy money party will continue

yellen_janet_040512_8x10Vivek Kaul

The Federal Open Market Committee(FOMC) which decides on the monetary policy of the United States in a statement released yesterday said “the Committee [has] decided to conclude its asset purchase program this month.”
What the Federal Reserve calls “asset purchase program” is referred to as “quantitative easing” by the economists. In simple English this is just the good old money printing with a twist. Since the start of the financial crisis, the Federal Reserve has printed around $3.6 trillion of new money.
This month the Federal Reserve has printed around around $15 billion. It has pumped this money into the financial system by buying government bonds and mortgage backed securities. From November 2014, the Federal Reserve will no longer print money to buy government and private bonds.
So why is the Federal Reserve bringing money printing to an end? The simple reason is that with so much money being printed and pumped into the financial system, there is always the threat of too much money chasing too few goods, and leading to a massive price rise in the process. Even though something like that has not happened the threat remains.
As John Lanchester writes in How to Speak Money “More generally QE[quantitative easing] taps into the fear that governments printing money always leads to dangerous levels of inflation, and that inflation, like a peat-bog fire, is all the more dangerous when it’s cooking up underground.”
There have been too many instances of money printing by the government leading to massive inflation in the past. And the Federal Reserve couldn’t have kept ignoring it.
Lanchester perhaps describes quantitative easing(QE) in the simplest possible way and what it really stands for by cutting out all the jargon in his new book How to Speak Money. As he writes “QE involves a government buying its own bonds using money which doesn’t actually exist. It’s like borrowing money from somebody and then paying them back with a piece of paper on which you’ve written the word ‘Money’ – and then, magically, it turns out that the piece of paper with ‘Money’ [written] on it is actually real money.”
Lanchester describes QE in another way as well. He compares it to a situation where an individual while looking at his “bank balance online” also has “the additional ability to add to it just by typing numbers on [his] keyboard.” “Ordinary punters can’t do this, obviously, but governments can; then they use this newly created magic money to buy back their own debt. That’s what quantitative easing is,” writes Lanchester.
This has been done in the hope that with all the newly money created being pumped into the financial system, there would be enough money going around and interest rates would continue to remain low. At lower interest rates the hope was people would borrow and spend more, and this in turn would lead to economic growth.
This did not turn out to be the case. What happened instead was that financial institutions borrowed money at very low interest rates and invested that money in financial markets all over the world. This explains to a large extent why stock markets have rallied all over the world in the recent past despite slow economic growth in large parts of the world.
So with the Federal Reserve deciding to stop money printing, will the era of easy money come to an end as well? The answer is no. For “easy money” junkies the party will continue. The Federal Reserve stated yesterday that “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial condition.”
What does this mean in simple English? The Federal Reserve has printed and pumped money into the financial system by buying bonds. It currently holds around more than $4 trillion worth of bonds. Bloomberg points out that this makes up for around 20% of all the bonds issued by the American government as well as mortgage backed securities outstanding. The Federal Reserve holds around $2.46 trillion of US government bonds.
In the days to come as these bonds mature, the Federal Reserve plans to use the money that comes back to it to buy more bonds. In this way it plans to ensure that the money that it has printed and pumped into the financial system, stays in the financial system.
Hence, Federal Reserve will not start sucking out all the money it has printed and pumped into the financial any time soon. And this means that the era of “easy money” will continue for the time being. The Federal Reserve also stated that fit plans keep interest rates low “for a considerable time following the end of its asset purchase program this month.”
By doing this, the Federal Reserve is essentially buying time. Currently, it is very difficult to predict how exactly the financial markets will react if the Fed decides to start sucking out all the money that it has printed and pumped into the financial system.
As Lanchester writes “Nobody quite knows what’s going to happen once QE stops. In fact, the ‘unwinding’ of the QE is on many people’s list as the possible trigger for the next global meltdown.” Further, even though the American economy is doing much better than it was in the past, the recovery at best has been fragile. The US economy grew by 4.6% during the period between July and September 2014, after having contracted by 2.1% during April to June, earlier this year.
The rate of unemployment in the US has been coming down for quite a while now. In September 2014, it stood at 5.9% against 6.1% in August. This rate of unemployment is around the average rate of unemployment of 5.83% between 1948 and 2014. It is also below the 6.5% rate of unemployment that the Federal Reserve is comfortable with.
Nevertheless, even with these reasons, the Federal Reserve is unlikely to start sucking out money and raising interest rates any time soon. This is because the US has become what Lanchester calls a “two-speed economy”. Lanchester defines this as “an economy in which different sectors are performing differently at the same time”. In the American context, it is a matter of Texas and the rest of the country.
The state of Texas has been creating more jobs than any other state in the United States. As Sam Rhines an economist at Chilton Capital Management points out in a recent article in The National Interest “From its peak in January 2008 through today, the United States has created only 750,000 jobs. Texas created over a million jobs during that same period—meaning that the rest of the country (RotC) is still short 300,000 jobs. During the recovery, job creation has been all Texas or—at the very least—disproportionately Texas.”
This has meant that the contribution that Texas has been making to the US economy has increased over the last few years, from 7.7% in 2006, it now stands at 9%. So, if one takes Texas out of the equation, the United States still hasn’t recovered all the jobs it lost since the start of the financial crisis in September 2008. Further, if one takes out the Texas growth out of the equation, the GDP growth also falls considerably. As Rhines writes “From 2007 through the end of 2013, the U.S. economy grew by $702 billion, and Texas grew by $220.5 billion.”
Other than this the broad unemployment numbers hide the fact that the labour force participation rate has been falling over the years. Labour force participation rate is essentially the proportion of population older than 15 years that is economically active. The number for September 2014 stood at 62.7%. This is the lowest number since 1978. The number had stood at more than 65% before the start of the financial crisis. Hence, more and more people are now not looking for jobs and they are no longer counted as unemployed.
Further, a lot of jobs being created are part-time jobs. Also, with jobs being difficult to come by many people looking for full-time jobs have had to take on part time jobs. In August 2014, nearly 7.3 million Americans were involuntarily working part time, compared to 4.6 million in December 2007, before the financial crisis had started. In September 2014, this number dropped to 7.1 million. Even after this fall, the number remains disproportionately high. This underemployment is not reflected in the rate of unemployment number.
Janet Yellen obviously understands this. As she had said in a press conference in September 2014 “There are still too many people who want jobs but cannot find them, too many who are working part-time but would prefer full-time work.”
Taking all these factors into account the Federal Reserve is unlikely to start sucking out all the money it has printed and pumped into the financial system any time soon. Nevertheless, whenever it gets around to doing that there will be trouble ahead.
Lanchester perhaps summarises the situation well when he says: “If a medicine is guaranteed to make you very sick when you stop taking it, and you know that one day you’ll have to stop taking it, then maybe you shouldn’t start taking it in the first place.”
But that at best is a benefit of hindsight. The horse, as they say, has already bolted by now. Alan Greenspan, the former Chairman of the Federal Reserve, recently said that the next phase of Fed’s retreat would not be so smooth and the Fed would not able to avoid turmoil. “I don’t think it’s possible,” Greenspan said.

The column is an updated version of a column that appeared on October 29, 2014. You can read it here.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

ECB joins the money printing party and launches QE lite

euro

Vivek Kaul

The European Central Bank (ECB) led by Mario Draghi has decided to cut its main lending rate to 0.05% from the current 0.15%. It has also decided to cut the deposit rate to –0.2%.
European banks need to maintain a certain portion of their deposits with the ECB as a reserve. This is a regulatory requirement. But banks maintain excess reserves with the ECB, over and above the regulatory requirement. This is because they do not see enough profitable lending opportunities.
As of July 2014, the banks needed to maintain reserves of € 104.43 billion with the ECB. Banks had excess reserves of € 109.85 billion over and above these reserves. The ECB was paying a negative interest rate of –0.1% on these reserves. Now it will pay them –0.2% on these reserves. This means that banks will have to pay the ECB for maintaining reserves with it, instead of being paid for it.
These rate cuts have taken the financial markets by surprise. When the ECB had last cut interest rates in June earlier this year, it had indicated that would go no further than what it had at that point of time. Nevertheless it has.
So what has prompted this ECB decision? In August 2014, inflation in the euro zone (countries which use euro as their currency) dropped to a fresh five year low 0.3%. In fact, in several countries prices have been falling. From March to July 2014, prices fell by –1.5% in Belgium, –0.4% in France, –1.6% in Italy and –1% in Spain.
In an environment of falling prices, people tend to postpone their purchases in the hope of getting a better deal in the future. This, in turn, impacts business revenues and economic growth. Falling business and economic growth leads to an increase in unemployment. And this has an impact on purchasing power of people.
Those unemployed are not in a position to purchase beyond the most basic goods and services. And those currently employed also face the fear of being unemployed and postpone their purchases. The rate of unemployment in the euro zone stood at 11.5% in July 2014. This has improved marginally from July 2013, when it was at 11.9%. The highest unemployment was recorded in Greece (27.2 % in May 2014) and Spain (24.5 %).
Hence, the ECB has cut interest rates in the hope that at lower interest rates, people will borrow and banks will lend. Once this happens, people will borrow and spend money, and that will lead to some economic growth. But is that likely the case?
The numbers clearly prove otherwise. In June 2014, the ECB decided for the first time that it would charge banks for maintaining excess reserves with it. In April 2014, the excess reserves of banks with the ECB had stood at € 91.6 billion. The hope was that banks would withdraw their excess reserves from the ECB and lend that money. The excess reserves have since increased to € 109.85 billion. What does this tell us? Banks would rather maintain excess reserves with the ECB and pay money for doing the same, rather than lend that money.
The ECB had cut the interest rate on excess deposits to 0% in July 2012. Hence, the negative interest rate on excess deposits has been around two years, without having had much impact. In fact, the loans made to companies operating in the euro zone is currently shrinking at 2.3%.
Also, banks always have the option of maintaining their excess reserves in their own vaults than depositing it with the ECB. They can always exercise that option and still not lend. Interestingly, in July 2012, the central bank of Denmark had taken interest rates into the negative territory. The lending by Danish banks fell after this move.
The Draghi led ECB has also decided to crank up its printing press and buy bonds, though it refused to give out the scale of the operation. The ECB plan, like has been the case with other Western central banks, is to print money and pump that money into the financial system by buying bonds. This method of operating has been named “quantitative easing” by the experts. The Federal Reserve of United States, the Bank of England and the Bank of Japan have operated in this way in the past.
The hope as always is to ensure that with so much money floating around in the financial system, banks will be forced to lend and this, in turn, will rekindle economic growth.
The ECB has plans of printing money and buying covered bonds issued by banks as well as asset backed securities(ABS). Covered bonds are long-term bonds which are “secured,” or “covered,” by some specific assets of the bank like home loans or mortgages. The ABS are essentially bonds which have been created by “securitizing” loans of various kinds.
The size of the ABS market in Europe is too small, feel experts, for these purchases to have much of an impact. Nick Kounis, an economist at ABN Amro told the Economist that “the likely size of possible purchases would be €100 billion to €
150 billion.” This is too small to make any difference. Bonds covered by home loans and worth buying could amount to another € 500 billion.
Further, the buying of ABS is unlikely to begin at once. As Ambrose Evans-Pritchard of The Telegraph put it on his blog “Buying may not begin in earnest until early next year since the ABS market is not ready.”
All this makes Evans-Pritchard conclude that “this would be a form of “QE lite” but it would be trivial compared with the huge operations of the Bank of Japan and the US Federal Reserve, together worth €120bn a month at their peak.”
If the ECB has to launch a serious form of quantitative easing it needs to be buying government bonds. But any such move is likely to be opposed by the Bundesbank, the German central bank. As the Economist put it “such an intervention would be bitterly opposed by the Bundesbank on the grounds that it would redistribute fiscal risks among the 18 member states that belong to the euro.”

The article was published on www.FirstBiz.com on Sep 5, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

How Obama and Manmohan Singh will drive up the price of gold


Vivek Kaul

‘Miss deMaas,’ Van Veeteren decided, ‘if there’s anything I’ve learned in this job, it’s that there are more connections in the world than there are particles in the universe.’
He paused and allowed her green eyes to observe him.
‘The hard bit is finding the right ones,’ he added. – Chief Inspector Van Veeteren in Håkan Nesser’s The Mind’s Eye
I love reading police procedurals, a genre of crime fiction in which murders are investigated by police detectives. These detectives are smart but they are nowhere as smart as Agatha Christie’s Hercule Poirot or Sir Arthur Conan Doyle’s Sherlock Holmes. They look for clues and the right connections, to link them up and figure out who the murderer is.
And unlike Poirot or Holmes they take time to come to their conclusions. Often they are wrong and take time to get back on the right track. But what they don’t stop doing is thinking of connections.
Like Chief Inspector Van Veeteren, a fictional character created by Swedish writer Håkan Nesser, says above “there are more connections in the world than there are particles in the universe… The hard bit is finding the right ones.”
The murder is caught only when the right connections are made.
The same is true about gold as well. There are several connections that are responsible for the recent rapid rise in the price of the yellow metal. And these connections need to continue if the gold rally has to continue.
As I write this, gold is quoting at $1734 per ounce (1 ounce equals 31.1 grams). Gold is traded in dollar terms internationally.
It has given a return of 8.4% since the beginning of August and 5.2% since the beginning of this month in dollar terms. In rupee terms gold has done equally well and crossed an all time high of Rs 32,500 per ten grams.
So what is driving up the price of gold?
The Federal Reserve of United States (the American central bank like the Reserve Bank of India in India) is expected to announce the third round of money printing, technically referred to as quantitative easing (QE). The idea being that with more money in the economy, banks will lend, and consumers and businesses will borrow and spend that money. And this in turn will revive the slow American economy.
Ben Bernanke, the current Chairman of the Federal Reserve, has been resorting to what investment letter writer Gary Dorsch calls “open mouth operations” i.e. dropping hints that QE III is on its way, for a while now. The earlier two rounds of money printing by the Federal Reserve were referred as QE I and QE II. Hence, the expected third round is being referred to as QE III.
At its last meeting held on July 31-August 1, the Federal Open Market Committee (FOMC) led by Bernanke said in a statement “The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.” The phrase to mark here is additional accommodation which is a hint at another round of quantitative easing. Gold has rallied by more than 8% since then.
But that was more than a month back. Ben Bernanke has dropped more hints since then. In a speech titled Monetary Policy since the Onset of the Crisis made at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, on August 31, 2012, Bernanke, said: “Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
Central bank governors are known not to speak in language that everybody can understand. As Alan Greenspan, the Chairman of the Federal Reserve before Bernanke took over once famously said ““If you think you understood what I was saying, you weren’t listening.”
But the phrase to mark in Bernanke’s speech is “additional policy accommodation” which is essentially a euphemism for quantitative easing or more printing of dollars by the Federal Reserve.
The question that crops up here is that FOMC in its August 1 statement more or less said the same thing. Why didn’t that statement attract much interest? And why did Bernanke’s statement at Jackson Hole get everybody excited and has led to the yellow metal rising by more than 5% since the beginning of this month.
The answer lies in what Bernanke said in a speech at the same venue two years back. “We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly,” he said.
The two statements have an uncanny similarity to them. In 2010 the phrase used was “additional monetary accommodation”. In 2012, the phrase used became “additional policy accommodation”.
Bernanke’s August 2010 statement was followed by the second round of quantitative easing or QE II as it was better known as. The Federal Reserve pumped in $600billion of new money into the economy by printing it. Drawing from this, the market is expecting that the Federal Reserve will resort to another round of money printing by the time November is here.
Any round of quantitative easing ensures that there are more dollars in the financial system than before. To protect themselves from this debasement, people buy another asset; that is, gold in this case, something which cannot be debased. During earlier days, paper money was backed by gold or silver. When governments printed more paper money than they had precious metal backing it, people simply turned up with their paper at the central bank and demanded it be converted into gold or silver. Now, whenever people see more and more of paper money, the smarter ones simply go out there and buy that gold. Also this lot of investors doesn’t wait for the QE to start. Any hint of QE is enough for them to start buying gold.
But why is the Fed just dropping hints and not doing some real QE?
The past two QEs have had the blessings of the American President Barack Obama. But what has held back Bernanke from printing money again is some direct criticism from Mitt Romney, the Republican candidate against the current President Barack Obama, for the forthcoming Presidential elections.
“I don’t think QE-2 was terribly effective. I think a QE-3 and other Fed stimulus is not going to help this economy…I think that is the wrong way to go. I think it also seeds the kind of potential for inflation down the road that would be harmful to the value of the dollar and harmful to the stability of our nation’s needs,” Romney told Fox News on August 23.
Paul Ryan, Romney’s running mate also echoed his views when he said “Sound money… We want to pursue a sound-money strategy so that we can get back the King Dollar.”
This has held back the Federal Reserve from resorting to QE III because come November and chances are that Bernanke will be working with Romney and Obama. Romney has made clear his views on Bernanke by saying that “I would want to select someone new and someone who shared my economic views.”
So what are the connections?
So gold is rising in dollar terms primarily because the market expects Ben Bernanke to resort to another round of money printing. But at the same time it is important that Barack Obama wins the Presidential elections scheduled on November 6, 2012.
Experts following the US elections have recently started to say that the elections are too close to call. As Minaz Merchant wrote in the Times of India “Obama’s steady 3% lead over Romney has evaporated in recent opinion polls… Ironically, one big demographic slice of America’s electorate could deny Obama a second term as president: white men. Up to an extraordinary 75% of American Caucasian males, the latest opinion polls confirm, are likely to vote against Obama… the Republican ace is the white male who makes up 35% of America’s population. If three out of four white men, cutting across Democratic and Republican party lines, vote for Mitt Romney, he starts with a huge electoral advantage, locking up over 25% of the total electorate.” (You can read the complete piece here)
If gold has to continue to go up it is important that Obama wins. And for that to happen it is important that a major portion of white American men vote for Obama. While Federal Reserve is an independent body, the Chairman is appointed by the President. Also, a combative Fed which goes against the government is rarity. So if Mitt Romney wins the elections on November 6, 2012, it is unlikely that Ben Bernanke will resort to another round of money printing unless Romney changes his mind by then. And that would mean no more rallies gold.
But even all this is not enough
All the connections explained above need to come together to ensure that gold rallies in dollar terms. But gold rallying in dollar terms doesn’t necessarily mean returns in rupee terms as well. For that to happen the Indian rupee has to continue to be weak against the dollar. As I write this one dollar is worth around Rs 55.5. At the same time an ounce of gold is worth $1734. As we know one ounce is worth 31.1grams. Hence, one ounce of gold in rupee terms costs Rs96,237 (Rs 1734 x Rs 55.5). This calculation for the ease of simplicity does not take into account the costs involved in converting currencies or taxes for that matter.
If one dollar was worth Rs 60, then one ounce of gold in rupee terms would have cost around Rs 1.04 lakh. If one dollar was worth Rs 50, then one ounce of gold in rupee terms would have been Rs 86,700. So the moral of the story is that other than the price of gold in dollar terms it is also important what the dollar rupee exchange rate is.
So the ideal situation for the Indian investor to make money by investing in gold is that the price of gold in dollar terms goes up, and at the same time the rupee either continues to be at the current levels against the dollar or depreciates further, and thus spruces up the overall return.
For this to happen Manmohan Singh has to keep screwing the Indian economy and ensure that foreign investors continue to stay away. If foreign investors decide to bring dollars into India then they will have to exchange these dollars for rupees. This will increase the demand for the rupee and ensure that it apprecaits against the dollar. This will bring down the returns that Indian investors can earn on gold. As we saw earlier at Rs60to a dollar one ounce of gold is worth Rs 1.04 lakh, but at Rs 50, it is worth Rs 86,700.
One way of keeping the foreign investors away is to ensure that the fiscal deficit of the Indian government keeps increasing. And that’s precisely what Singh and his government have been doing. At the time the budget was presented in mid March, the fiscal deficit was expected to be at 5.1% of GDP. Now it is expected to cross 6%. As the Times of India recently reported “The government is slowly reconciling to the prospect of ending the year with a fiscal deficit of over 6% of gross domestic project,higher than the 5.1% it has budgeted for, due to its inability to reduce subsidies, especially on fuel.
Sources said that internally there is acknowledgement that the fiscal deficit the difference between spending and tax and non-tax revenue and disinvestment receipts would be much higher than the calculations made by Pranab Mukherjee when he presented the Budget.” (You can read the complete story here).
To conclude
So for gold to continue to rise there are several connections that need to come together. Let me summarise them here:
1. Ben Bernanke needs to keep hinting at QE till November
2. Obama needs to win the American Presidential elections in November
3. For Obama to win the white American male needs to vote for him
4. If Obama wins,Bernanke has to announce and carry out QE III
5. With all this, the rupee needs to maintain its current level against the dollar or depreciate further.
6. And above all this, Manmohan Singh needs to keep thinking of newer ways of pulling the Indian economy down
(The article originally appeared on www.firstpost.com on September 11,2012. http://www.firstpost.com/economy/how-obama-and-manmohan-will-drive-up-the-price-of-gold-450440.html)
(Vivek Kaul is a writer and can be reached at [email protected])