(In this two-part series, we look at India's gold imports in the context of its foreign exchange problems. Click here for the first part of this article)
But, aren’t gold imports, however small, a waste of money? After all, gold has no intrinsic value.
|Fig. 3: World's Central Banks are sitting on huge Gold Reserves|
Neither does paper money! Let us first look at some more points of data (Figure 3). It is known that all Central Banks are holding large reserves of Gold as part of their foreign currency reserves. The adjacent table that shows that even those countries who are facing severe economic stress, are holding large amounts of gold as part of their foreign exchange reserves. (Even China is playing catch up and is in fact set to emerge as the world’s largest gold importer)
|Fig. 4: Central Banks have become net buyers in Gold in recent years|
Not only are the Central Banks holding large quantities of Gold, but are increasing them further (see Figure 4). In 2012 too, Central Banks have remained net buyers of the yellow metal, as these reports suggest (click here or here). If gold had no intrinsic value, why are the Central Banks themselves, who supposedly understand money better than us, sitting on so much gold and buying more?
The fact is, Central Banks understand that gold is money, and money does not have intrinsic value. Your currency note derives its value from the promise of the Central Bank printed on it. Gold derives its value from the value attached to it by thousands of years of human civilization. To destroy value of paper money, you just need to print more money (to elaborate on this is beyond the scope of this article, but the interested reader can refer to this excellent article on inflation). To destroy value of gold, you need to change the subjective opinions of billions of people (and Central Banks) all over the world. The reader can decide what is easier.
Even India's Central Bank, which itself bought 200 tonnes of gold in 2009 had this to say last week: "Gold is easily accessible. It is a store of value, has no credit risk and is relatively liquid thereby incentivising many households to buy gold” (RBI's Financial Stability Report (FSR) released on 28th December 2012).
But gold has no cash flows, pays no interest or dividends and is risky to store.
A common argument made against gold, but gold is not an equity share at all. So aren't we comparing apples with oranges here? Gold is not an investment at all. Gold is money, gold is currency, gold is wealth. I would use the cash flow argument only to evaluate an equity share, not gold.
But of course, you can’t take a milligram of gold to the grocer to buy your stuff, right?
Right. Nobody disputes the need for paper (or digital, these days) money. This article should not be construed as an invesmtent advice, nor am I saying that gold prices will continue to rise perpetually. The purpose of this article is only to highlight that gold imports are nowhere as problematic as they are being made out to be and one needs a different perspective to understand gold.
It is estimated that Indian households own more than 17500 tonnes of gold accumulated over centuries of civilization. Despite two decades of economic reforms, it is pointed out that
’s equity investor population has actually shrunk – a surprising statistic given
the importance the stock markets are attached to by policy makers and the media. Performance of mutual funds has been disappointing, to say the least, and double
digit inflation has made investing in fixed income instruments a loss making proposition. Gold and property are the only assets
where Indian people have seen their wealth grow. Since buying property needs deep
pockets, gold has emerged as the only asset which people can accumulate in
small quantities. In fact, in the FSR mentioned earlier, the RBI has admitted low interest rates have caused households to shift away from financial assets to physical assets and valuables such as gold. “Gold prices have increased the most in comparison with other assets and are significantly above the movement in WPI (i.e. inflation)” it said. It has proposed inflation indexed bonds as an option, which it hopes can reduce demand for gold. India
Blaming gold imports suits the political class, as it shifts the blame of
economic ills away from its own mismanagement to the Indian public. But it is
for us to analyze data, ask the right questions and
make intelligent judgement. Gold imports are neither frighteningly high, nor
the cause of India's currency problems. Nor are Indians alone in buying gold. If people are buying more gold, there are reasons for the same. Those reasons need to be addressed. Other avenues to park money need to be made more attractive. Raising taxes or banning imports
will only encourage smuggling, punishing the honest and rewarding the
dishonest. Key non-gold imports, such as oil or defence need to be reduced by increasing
domestic production. Exports need to be increased by controlling
inflation (since higher domestic costs reduce export competitiveness). Interest
rates need to be increased, and should be higher than inflation rate, in order to encourage
savings in financial assets like bank deposits. Until that happens, people will
continue to buy gold, and for a good reason. India
President Roosevelt’s order had permanently pegged the price of 1 oz. of gold at $ 35 and committed the
government to exchange dollars for gold at this rate with anyone on demand. After
World War II, backed by gold, the U.S. Dollar emerged as the primary currency
of global trade. All international transactions and agreements, no matter
between which two countries and what their currencies, came to be denominated
in U.S.dollars. But thanks to inflation, the dollar continued to lose its value while gold held its own. By the early 1970s, it was
clear that an ounce of gold was much more valuable than the $ 35 that the U.S.
government paid for it. The demands on America to redeem dollars for gold increased
dramatically. In 1971, faced with a run on its gold, President Nixon announced that it was ending the peg of the dollar to
the gold, letting it float freely in international markets. In the next 10 years, the price of gold
shot up more than 10 times to more than $ 400 per ounce and is trading at $ 1650 today. U.S.