India's Sensible Plan To Mobilise The Gold Reserves

Mumbai-India (Apr 23)  This looks like a very sensible policy goal in India, a desire to mobilise the country’s huge stocks of gold in private hands. However, I’ve more than a sneaking feeling that the precise policies being offered to achieve the goal aren’t quite what is needed. The basic goal being that there’s an awful lot of capital and savings tied up in the gold hoards in that private sector. And it would probably be better if that capital were circulating, adding to the capital stock of the economy, rather than just sitting there and glittering. So, the idea of mobilising it sounds just great. But how to do so? I think I would argue that the best policy would be one that pretty much ignores gold: a policy of making sure that everyone is banked would be better.

Here’s the basic idea:

“In his mission to build India’s economy into one that could someday rival China’s, Prime  Minister Narendra Modi would like to mobilize the roughly 20,000 tons of gold thought to be in private hands, 2,500 tons of it in major Hindu temples. Demand here is so high that gold imports have in recent years accounted for nearly 30 percent of India’s trade deficit, and many people prefer to keep it in the form of jewelry, making it difficult to trade or convert into cash.

Economists call it “idle gold,” and Mr. Modi’s team would like to see it used for trade and investment. In May, the government is expected to introduce a plan to induce Indians to deposit gold in banks, offering fixed interest rates for a “metal account.” There are also plans to issue gold bonds and, for the first time, to issue gold in the unsentimental but fungible form of a coin.

In technical terms that’s what we might call “a whole lotta gold”. Something in the $600 to $700 billion range in value. And in a capital poor country like India we might well think that that sort of sum would be better feeding the fires of industry rather than just being jewelry and savings. So, trying to mobilise it through gold bonds and so on seems reasonable. But we might also want to take a step back and think why it is that Indians save using gold rather than, say, a bank account?

Of course, tradition plays some part in this. Out in the country a little bit of gold jewelry can represent the household’s savings. In dire times it’s possible to pawn, or even sell it, in order to raise needed funds. So the function of such gold holdings is more than just adornment: it’s also a method of saving.

However, from a macroeconomic point of view we’d rather people saved in a manner that then allowed other people to use those savings to invest. And this is not what saving via gold really allows. We’d much prefer that people saved their emergency money in banks, so that other people (through the miracle of fractional reserve banking and maturity transformation) could then borrow that money to go build factories, homes and jobs. The question thus is why doesn’t this happen?

One obvious reason is simply historical and cultural. But such practices always come from somewhere. And there’s two that we can quickly identify. The first being that the value of cash money (and thus bank deposits and so on) in India has not been stable historically. Thus savings tend to end up somewhere which is a store of value, not in a currency being inflated away. Given the much better performance on inflation in recent years this reason is fading away somewhat. The second is that still vast numbers of Indians are entirely unbanked. They simply don’t have an account and no real possibility of gaining one. Either for geographic reasons or because the banking system as it is just isn’t set up to deal with the small amounts that many people are dealing in.

There are official attempts to change this being enacted and we’ve also got the spread of mobile phones. There’s many examples of things similar to M-Pesa being trialed in India and these will change attitudes as well. For one of the things that really surprised people about micro-banking and such systems as M-Pesa was the way that the poor really, really, desired to have a safe and secure savings method.

All of this means that things like gold bonds might well help at the margins. But my opinion is that the more effective methods will come from expanding poor peoples’ access to banking services, both through the plans already being mooted (for example, the idea of moving from food aid in kind to cash payments requires that everyone have a basic banking account) and also through that technological change of mobile banking. Nothing at all wrong with what is being done and the policy aim is entirely sensible. Only that the goal is more likely to be achieved through the more basic changes going on in the economy as a whole rather than these specific measures.

Source: FORBES