Why RBI's fresh attack on gold is also doomed to fail

The Reserve Bank of India (RBI) has more or less destroyed one good business for banks. The 2013-14 monetary policy, announced last Friday, makes two major changes in respect to gold imports that will shrink banks’ profits from this metal. This means borrowers will have to wait a wee bit longer for lower interest rates. If banks make less money from non-fund businesses like gold trading and lending, they have to make it by keeping basic rates high.

The two changes announced the RBI Governor relate to a ban on banks importing gold on a “consignment” basis for anyone other than jewellery exporters, and restricting banks from lending against gold coins beyond 50 gm per customer. At current prices, this means banks can lend less than Rs 1 lakh to each customer, since they can’t lend upto the full value of 50 gm of gold. More so, in a climate where gold prices are falling worldwide.

There may be short-term macroeconomic reasons for curtailing the import of gold. Gold has been the second biggest item of import after oil for India, and in a situation where the current account deficit is likely to be an unsustainable 5 percent, discouraging gold imports temporarily may seem like a good idea to policy-makers.

However, at a time when gold prices are falling, the RBI action seems more like vengeful action. What lies behind this?

The unstated reason why governments and central banks dislike gold is simple: gold is money, and they don’t like anyone else creating money even when they won’t restrain their own excessive printing and debauching of paper money.

Central banks have since 2008 flooded the markets with paper, using Keynesian gobbledygook terms (“Quantitative Easing”) to justify this currency debauchery. They have almost abolished interest rates, making paper money steadily worth less. In the US, Europe and Japan, central bank interest rates are near zero and in India real interest rates after adjusting for inflation have been negative for years now.

There is nothing central banks would like more than wishing the demise of gold because it would then leave individuals at their complete mercy. Governments feel less macho when gold shows them up.

Faced with central banks printing truckloads of money, citizens have only two options to avoid losing their hard-earned wealth to inflation or other forms of financial repression: one is to seek alternative forms of money that are outside the control of central banks, and the other is do business only through barter.

If you leave out barter, which, by definition is just a form of exchange and hardly ideal as money, it leaves only gold as the citizen’s option. This is why the RBI is trying to stamp it out.

In India, gold has value not only as money but as jewellery too. It thus has both use value and exchange value. This is why the RBI is running scared. It knows that Indians will use the current fall in gold prices not to sell, but to buy steadily.

There is no other reason why a central bank should tell banks that they should avoid selling gold coins, and that they should not lend against gold beyond 50 gm.

Unfortunately for the RBI, this ploy will not work. It never has.

When official channels close, citizens will shift to private jewellers for gold, who will be more than happy to make higher margins on this business.

When banks cannot import gold on a “consignment” basis, Dawood & Co and other crime syndicates will be happy to step in.

When banks won’t lend against gold coins, private moneylenders will. Banks which talk of inclusive banking - and gold is the greatest inclusivist, since it is universally accepted as collateral in India - will now find that they have created a new form of exclusion.

The RBI’s move has to be put down to two reasons: one must be pressure from the finance ministry, and the other must be its own short-sightedness in understanding the damage such bans cause.

It is also an admission of defeat on inflation. Hidden in it is a message that it cannot resist political pressure to ease money when CPI inflation is still in double-digits. Citizens have to prepare for more financial repression and an attack on their wealth.

The RBI’s monetary policy is of no use if it does not understand the basics of what good money is about. It’s about maintaining value over time. Banning gold is tantamount to shooting the messenger.