Tuesday, June 5, 2012

Countering Anti Gold Tirade

Would continue with the Part 2 of the Deflation vs Inflation debate, for now posting my recent publication in Hindu Business Line Link

Even though the gold contract has broken through the 30,000 rupees barrier, we still hear of statements coming out from some of the country’s bankers and government officials aimed at discouraging people to invest in Gold, terming such a saving as wastage of “National Wealth” and impacting growth. Gold is blamed for two primary reasons. The investment is non-productive as gold is hardly used in industrial production and it has contributed to the high current account deficit of the country.

Assuming these comments are well intentioned they only demonstrate a colossal misunderstanding of the very concept of “Savings”. What’s worse is that such comments implicitly demeans the smart Indian masses who know it better than most, how to preserve whatever little wealth they have than most of their western counterparts.

Savings is a process by which you don’t immediately consume the fruits of your labour so that you are able to consume a little more at a later stage in life or during some emergency. So when you save, you give up consumption of real resources like oil, labour, food etc. and these resource are thus freed to be then taken up by the entrepreneurs and put into productive use by the process of investment, thus increasing the productivity of the nation and its people and in the process generating what we call future wealth and economic growth.
With this understanding one should realise that you can save by buying into bonds, equities, bullion, cash or even for that matter a “pebble on the roadside!!!”; it is certainly not a “wastage of national wealth” as such a saving  would mean that real resources are freed for the entrepreneur to invest and create new products. So by calling gold investment a wastage is simply erroneous and misleading, on the contrary as indicated above the savings should happen in assets which actually have no real use, apart from this two other features that determines the popularity of the saving asset is that it should neither be abundant nor too scarce and whose quantity can’t be increase at free will; gold pretty much fits that bill.
The asset in which you save the fruits of your labour acts as a wealth transfer medium and so even if your saving decision is not a wastage of the wealth of the society as a whole, it would certainly determine how better off would you be some years down the road when you chose to consume those savings; at the expense/benefit of others.
Certainly saving in the roadside pebble would turn out to be worthless for you and as we would see by investing in gold, Indian’s have been able to preserve their wealth from the government’s constant financial repression.
Coming onto the second point for gold bashing; gold leads to a loss of precious forex reserves. Well granted that since India imports its entire gold needs there is an argument atleast on the surface against loss of foreign reserves due to gold. However it is a very superficial way of looking at things, loss of forex reserves is a natural market phenomenon under the current economic context and gold just acts as a medium for that. Let me explain briefly
There is only one way for the runaway inflation to come down, by reducing the credit growth in the economy. This can be easily achieved without compromising growth if the government is able to reduce its penchant to spend the taxpayers money however without any move on the fiscal side; on the monetary front this can be achieved by the Central bank pushing the interest rates even higher; there is a third way by which the credit in the system can be reduced, as the forex reserves move out of the country the corresponding liabilities against them i.e. the rupee liquidity has to reduce sans of any RBI intervention through OMO’s or CRR cuts and this  is exactly what is happening through the gold imports. In any case the forex inflows can be replenished by issuing Gold Bonds, however this would be a wrong step as it would mean increasing the money supply/credit in the domestic economy and thus stoking further inflation, pretty much counteracting the impact of gold imports.
So investing in gold is not a waste of national wealth but a preservation of individual wealth as the real resources within the country are not affected, the pillage of the real resources is happening because of the government’s obstinacy to continue spending which is reflected by the free markets in the form of higher interest rates and forex outflows.
Lastly an argument can be made that instead of gold if money can be put in stocks; while stocks are surely a good medium to save one’s wealth; however unlike gold the supply of stocks can be changed by keystrokes, but more importantly a look at the graph would show that compared to gold timing is extremely important while putting your savings in stocks as they would not prove to be an ideal hedge against inflation because unlike gold by investing in stocks the total credit/money supply in the economy doesn’t come down.
As one can see, gold has been a more stable investment vehicle over stocks, rising gradually over the years. Stocks are far more volatile and although they have certainly outperformed over gold intermittently (during periods of increased private sector credit growth and low inflation) but ultimately they mean revert to the trendline set by gold (happens during periods of credit slowdown or high inflation).


So investing in Gold is by no means a national waste of resources but instead it’s a medium by which the economic follies of the government are corrected. Sure the reduction in credit growth does hurt the profitability of the banks and that’s why they have every right to be against investing in this metal but as explained before their profitability does not vanish in thin air but transferred to the bullion investors.


Jagdish said...


Excellent article. From and Indian perspective its good to invest in bullion as it protects from currency devaluation and inflation.

But is it attractive to invest in $ as well?
A Forbes article says that the current bull run in bullion is a bubble:

When did they start gold ETFs in large volumes ? What price do you think is sustainable and will give earnings?

Stochastic Process said...

Hey Jagdish, Sorry for replying late... Gold bought in physical form is good enough than holding any currency in bank account. Having said that in notional terms i.e. in dollar value gold has been up 11 years in a row and possibly can go for a deeper correction even from here as I see a develeraging cycle kicking in next year and the dollar and other paper currencies as well can gain a lot more in terms of gold intermediately. So just to summarise :) though gold may correct significantly in the intermediate term but it is no way a bubble as it is just responding to the structural deficiencies in our monetary system. I can't predict a level really because it would all depend upon the supply of paper money but for sure it would be one of the most profitable macro investment.