[Photo caption/credit: Government Squeezes the Savings–and Independence–Out of People (courtesy Google Images)]
Reuters published “India’s ‘gold monetization’ scheme could have a big impact on global demand”. According to that article:
“Last week the Indian government approved the so-called gold-monetization scheme . . . [by] creating a system in which Indians holding private gold will be able to deposit it at banks—and then earn interest on their bullion holdings.
“The government plans to then make the deposited gold available to buyers across India. The aim is to reduce gold imports from outside the country, which run at nearly 1,000 tonnes yearly.
“India’s cabinet also approved a ‘gold bond’ program in which citizens will be able to buy interest-bearing bonds backed by gold, rather than owning physical gold.
“Estimates are that private citizens across India hold tens or even hundreds of millions of ounces of gold—which could become available to the banking system, if the monetization program is well received.”
First, a metric ton weighs 2,200 pounds. If India imports 1,000 metric tons of gold at $1,200 per ounce, they’re importing $42 billion worth of gold each year.
India’s current GDP is about $2 trillion per year. Thus, India currently spends 2.1% of its annual GDP purchasing more gold from foreign sources. That’s 2.1% (more or less) last year; 2.1% this year; 2.1% next year. Note that US economists hope that the US economy will grow by 3% annually. Compare that 3% hope to India’s 2.1% annual drag on their economy due to purchasing foreign gold. You can see that 2.1% is a significant expense for an economy the size of India’s and cause for governmental concern.
Second, the Indian government now proposes that the Indian people deposit their privately-owned gold into bank accounts and accept a paper receipt in return. Then, the Indian government intends to sell the deposited gold to other Indians who wish to buy gold. The stated purpose for this scheme is said to be to reduce the amount of gold imported into India—but I doubt that’s the primary purpose.
I suspect that the Indian government is essentially trying to put gold into circulation as money rather than allow Indian women to continue to wear their accumulated gold as jewelry to demonstrate their wealth.
Why? What’s the Indian government have against gold jewelry and/or gold “saved” in the form of bracelets and necklaces? Well, I doubt that they have anything against gold, per se. But, as you’ll read, they may have a lot against savings.
The Reuters article also tells us that the primary, intended beneficiary of the new “gold-monetization scheme will be the bankers rather than the Indian people. One of the reasons Indians save/hoard gold is that they don’t trust their fiat currency (rupee), India’s bankers or India’s government. By admitting that the new “gold-monetization scheme” will primarily help the bankers, India’s government has almost certainly alienated the Indian people and guaranteed that their newly-proposed “scheme” will flop.
Even so, we can still learn a lot by considering India’s proposed “gold-monetization scheme”.
• For example, India’s fundamental monetary problem is that the Indian people traditionally turn their excess wages (paid in rupees) into gold, which they can bury in the back yard or give to their wives to wear as jewelry. Saving their gold is a well-established tradition and also an insurance policy against their government’s monetary malfeasance. However, by saving in the form of gold, Indians reduce the supply of rupees in the national currency supply or at least slow the velocity of money in their national economy.
By saving their wealth in any form, including gold, and thereby reducing the currency supply and/or slowing the velocity of money, the Indian people provide a deflationary force in the Indian economy which causes the national economy to be less vigorous and less prosperous than it might otherwise be. Wealth saved in the form of gold is taken out of “monetary circulation” and the Indian economy is thereby slowed or impaired.
If the Indian people own, say, 300 million ounces of gold, they’re a wealthy people holding about $330 billion worth of privately-owned gold. But, because they save that gold rather than spend it, none of that $330 billion is circulating in the Indian economy.
If that $330 billion were circulating in the Indian economy, it would stimulate the economy to grow faster and become more prosperous. Under a fractional reserve banking ratio of 10 to 1, if the Indian people deposited their gold into private banks, those banks could lend the equivalent of at least $10 for every $1 worth of gold deposited into their vaults. Thus, if the Indian government could persuade the Indian people to deposit even half of their estimated $330 billion in gold into the banks, the banks could lend about $1.6 trillion into the Indian economy. Given that India’s annual GDP is only about $2 trillion, an “extra” $1.6 trillion loaned into the economy could be very “stimulating”.
You can see why India’s government and banks would want to persuade Indians to deposit their gold into Indian bank vaults and then sell their gold to other Indians: doing so would actually reduce gold savings and place more gold/savings into circulation to stimulate the economy.
The problem is that the Indian people know from bitter experience that they can’t trust the fiat rupee, Indian government or Indian bankers. Therefore, they trust in gold. Big time. They won’t be easily persuaded that “this time it’s different” and they can trust the bankers, the government, and whatever gold-backed paper debt-instruments are about to be issued.
• By using their earned rupees to pay for imported gold, India’s people allow their rupees to be collected by foreign banks and businesses that then spend the rupees in India to buy India’s most prosperous businesses and valuable properties. That foreign ownership should also tend to drain profits out of India and slow and impoverish the Indian economy.
The Indian government presumably wants to diminish the growth of foreign ownership of prosperous Indian corporations and businesses. In order to do so, the Indian people must be prevented from buying gold from foreign sources.
1) the Indian culture reveres gold as a store of wealth; and,
2) the Indian people distrust the fiat rupee;
It follows that India’s appetite for gold savings is,
3) insatiable and is reducing India’s supply of currency (rupees) and/or slowing the velocity of money and thereby pushing its economy towards recession.
• The Indian government is helpless against the Indian people’s distrust of the fiat rupee, the banking system and the Indian government, itself. The government could print more fiat rupees, but that would only cause more inflation, more distrust of the rupee, higher prices for gold, more public demand for gold, more gold being imported by the Indian people, less rupees in circulation—and a persistent drag on India’s economy.
There are lessons here.
First, once a nation’s people lose trust in their government, currency or economy, they tend to save rather than spend.
Second, once that trust is lost, governments are hard-pressed to regain their trust and restore the economy.
Third, irresponsible governments inevitably destroy their own nations.
We see those lessons in India and perhaps also in the US.
I.e., during the Great Depression, the American people lost confidence in the government, economy and possibly the currency. They stopped unnecessary spending and saved whatever they could. The economy stayed in a depression until WWII began and managed to drag Americans out of a “savings” mentality back into spending and prosperity.
More recently, the US government’s irresponsible economic manipulations and creations of “bubbles” laid the foundation for the Great Recession of A.D. 2008. Since then, the American people have shown an increased tendency to save and a decreased tendency to spend. Repeated bouts of Quantitative Easing and Near Zero Interest Rates have so far failed to “stimulate” much additional spending in the US economy.
If the general theme of this article is roughly correct, I doubt that the US economy will be restored until the government figures out how to restore the American people’s former trust in the US government, the Federal Reserve and our fiat currency. Those who distrust government and national institutions like the Federal Reserve, tend to save rather than spend.
In just the last two or three years, the Indian government tried to stop the flow of gold into India by raising import barriers. That effort resulted in more smuggling of gold into India, a stronger black market for gold, and a rising market for silver and an increased outflow of rupees to foreign gold markets. The Indian government’s attempt to use a “stick” to stop Indians from buying foreign gold failed.
OK—given that the “stick” approach (import restrictions) failed, the Indian government is now trying to temp the Indian people with the “carrot” of a new-and-improved “gold monetization scheme”. I doubt that they’ll succeed.
• The Indian government seemingly believes that the easiest way it can stimulate their national economy is to persuade or deceive the Indian people into putting their gold into “circulation” with bank accounts denominated in gold or government bonds backed by gold.
In other words, if you can’t beat ‘em, join ‘em. Given that Indians don’t trust the fiat rupee, hoard gold, and reduce the money supply, the only way to “stimulate” the Indian economy may be (at least indirectly) to restore a gold-based monetary system that will put private Indians’ gold into “monetary circulation”.
I.e., India wants its people to deposit their gold into bank accounts and allow their gold to be resold to other Indians who will presumably deposit the same gold into their own bank accounts only to be sold again and an again to other Indian people. Thus, India’s gold would be taken out of private savings and put into “circulation” in the public economy.1
India’s slow-moving economy is being driven to recreate something like a gold-based monetary system because the Indian people: 1) are nearly fanatical in their dedication to save whatever wealth they acquire; 2) won’t trust anything other than privately-held gold to save their wealth.
A people’s money must be composed of something they trust. If they trust their government, you can make their money out of paper, electronic digits or government certified corn cobs. If they don’t trust their government, you must make their money out something physical like gold or silver.
But note well that the Indian economy isn’t being slowed by gold—it’s being slowed by savings.
The Indian government’s “gold monetization scheme” is less an attack on gold than it is on savings.
• The same hypothesis should apply to any nation whose people come to distrust their government, banks and fiat currency. As distrust builds, more and more people use their fiat currency to purchase gold and drive the price and desirability of gold upward. As people buy more gold and the prices rises, more of the nation’s wealth is taken out of circulation as fiat currency and saved in the form of physical gold—which tends to slow the economy.
The US Government has, for most of my lifetime, tried to stimulate the economy by inflating the dollar, making it persistently lose value and thereby encourage people to quickly spend their fiat currency rather than save it in banks, hidey holes, etc.. But, normally, inflation also pushes the price and desirability of gold higher, which causes more people to save their wealth in the form of gold rather than US dollars, which savings tends to reduce the supply of currency in circulation (or at least the velocity of money) and thereby slow the economy.
Written by Alfred Adask
Full report at Adask’s Law
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