By Shanmuganathan Nagasundaram
For the last several years, the Reserve Bank of India (RBI) has been running a highly inflationary monetary policy - with M3 growth averaging 17 percent plus, an after-tax savings rate on bank deposits at 6 percent plus and consumer price increases averaging around 10 percent plus. Ofcourse, all Austrian School economists would say that the very purpose of a central bank is to run an inflationary policy and that, if we did not want inflation, we would just go back to a gold monetary standard.
True to form, the rupee has lost almost 99 percent of its value against the US dollar since 1947 when the rupee was at parity with the dollar. The dollar itself has been no great paragon of virtue and has lost 98 percent of its value against gold in the same period ($35/ounce in 1947 to around $1,330 today). So to state the the RBI has decimated the value of the rupee would actually be an understatement of sorts.
But it continues to amaze me when I see the RBI Governors being extolled to the realm of divinity by the media. "Headless Chicken" would be a much more appropriate description of how they have performed over the last few decades, but especially so in the last few weeks wherein we have witnessed a set of confused actions as a response to the sharp depreciation of the rupee. In witnessing the actions in the bond market over the last few days, in which the yields on 10-year bond have moved up from 7 percent to 8.5 percent, and that too without any specific rate increase decisions by the RBI, I would have to state the chickens have indeed come home to roost.
The consequences of easy money: One would have to be really innocent of economics to argue that easy money would not have disastrous consequences. But "easier money" is precisely what much of the political class, CII, Ficci, etc, have been demanding all these years. Of course, I have been stating for a couple of years now that the RBI would be forced to hike rates at least by 300 basis points by 2015-16. Not because they want to or because the economy is in a tearing hurry, but because Mr Market would move decisively to force the hand of the RBI in that direction.
The actions of the last few weeks have been a confirmation that the process has started. Bonds that have been in a world-wide bull market for almost 35 years now are showing the first signs of bursting. This bull market in bonds has lasted for such a long time that most analysts of the bond market wouldn't have witnessed a bond bear market in their lifetimes. In most bubbles, private players are the biggest participants and hence we witness a rapid deleveraging when a bubble bursts. However, in the case of bonds, central banks are the biggest players and hence this process would be a long drawn-out affair, perhaps spreading over the next couple of decades. They would try to reflate the bubble through the mechanism of quantitative easing, but these actions can only slow down Mr Market. As Jim Rogers would love to say: "Bond traders better learn to drive tractors".
The era of bubbles bursting: The easy money policies worldwide have created many bubbles that would burst in the years to come. The most obvious one is the bond bubble - but there are several other bubbles that are a consequence of an artificially low interest rate regime - i.e. housing, autos etc. Perhaps what's not so very obvious is fiat currency bubble - and that will be one of the last bubbles to burst.
As we witness each of these dominoes falling, the winner is going to be gold. The RBI has done whatever it can, and my guess is that the US Fed is engineering these actions from behind the scenes through carrot and stick, to decrease the Indian appetite for gold. Little does the RBI realise that this appetite is a function of its negative real interest regime and unless that is changed, the demand is bound to continue.
All of the recent RBI actions against gold - restrictions on lending against gold, restrictions on gold loans to jewellers, tying gold imports to exports, stipulating wastage limits on jewellery - reflect the Nehruvian tendency to micromanage the system. But perhaps the underlying concern behind these knee-jerk reactions is that of a system that is clearly losing control over its monopoly status.
Apart from specific actions, there has also been a propaganda war against gold by the RBI as well as the government.
These "opinions" range from ignorance of the role of gold as money to a plain misstatement of facts as well as a misrepresentation of the role of gold in commerce. While I have addressed some of these issues in my earlier columns, I will address two specific issues that have been the subject of recent debates.
Overconsumption of gold: We are not overconsuming gold by any absolute standard of savings. The estimated gold in India accumulated from time immemorial is around 18,000-20,000 tonnes, which is around 0.6 billion ounces( i.e. around 18gm/person). Considering the current price of Rs 2,700 per gm, this is less than Rs 50,000. Even without accounting for distribution patterns of wealth wherein the wealthy are likely to be holding much more gold than the poor, this volume cannot by any stretch of imagination be considered substantial savings. Clearly, if the RBI is trying to project a scenario that Indians are saving excessively in terms of gold, the data does not back up that claim at all.
Is gold really a dead Investment? That is certainly a consequence of laws that guarantee a monopoly status to the RBI in the issuance of money. If the government were to permit private entrepreneurs to start gold banking with 100 percent reserve requirements, I am certainly sure that there would be plenty of takers for the business and consumers waiting in queues to sign up. What governments all over the world have done is very ironical: they have created legal tender laws that deter gold to circulate as money and then claim that gold is a dead investment.
Talking of ironies, the government has recently empowered Sebi to crack down on Ponzi schemes. The first place to begin for Sebi should be the RBI - fractional reserve banking is as blatant a Ponzi scheme as the one that Bernie Madoff was running.
What the RBI really needs to do: With his dismal track-record, it's hard to see Duvvuri Subbarao continuing beyond his current tenure. But none of the current crop of names doing the rounds - from Raghuram Rajan to Arvind Mayaram to Saumitra Chaudhuri - inspires any confidence whatsoever. After all, in all these years where the RBI has been continually debasing the rupee, they have expressed their support for a easy money policy either explicitly or through their silence.
What we really need at the RBI is far-reaching reforms that in effect end the monopoly of the RBI in the issuance of money. We need alternate and private monies to circulate and let the RBI compete against the barbaric relics with its PhD economists and let the markets decide the winners. Let us provide a choice to consumers about the currencies they want to save in - this would force the hand of the RBI to behave more responsibly in the future and not just bow down to the wishes of their political masters. This is really not a very outlandish idea as might appear and Ron Paul had even introduced a bill in the US Congress to this effect.
The current situation we are living through is very comparable to what the BSNL monopoly did to telecom and Indian Airlines did to civil aviation in India. I am sure there was a time when the Indian government cited national interests or security or whatever to justify a monopoly in these sectors. It will be no different this time around and the government would argue that money is different from other products and services. Indeed it is - and as Murray Rothbard would argue, which is all the more reason why we should not permit a monopoly status in the issuance of the same and any issuer ought to be subjected to the forces of markets and competition.
As Rothbard explains in "What has Government done to our money", an increased stock of money serves no overall societal benefit and merely serves to dilute the purchasing power of the existing stock of money and transfers this purchasing power to the early recipients of this newly-issued money. It is, therefore, imperative than the issuer of money be subject to an equivalent cost and the current situation, where it costs next-to-nothing for creating, say, a Rs 1,000 note, is tailor made for debasement of money. So we really shouldn't be surprised with what we are seeing in terms of the effects.
Who will do it? As said earlier, none of the potential successors would do anything to alter the current continuous debasement policy of the RBI, let alone end their monopoly status. We really need an "outsider" who understands the dynamics of global markets and monetary history to usher in the required reforms at the desired pace.
I can think of none better than Jim Grant. It's not that we necessarily need a foreigner, but just that nationality should not be a criterion for choosing Subbarao's successor. We really need the best man for the job and looking to survivors within the existing terribly flawed system isn't really a good starting point.
Shanmuganathan "Shan" Nagasundaramis the founding director of Benchmark Advisory Services - an economic consulting firm. He is also the India Economist for the World Money Analyst, a monthly publication of International Man. He can be contacted email@example.com
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Updated Date: Dec 20, 2014 21:19:15 IST