S S Tarapore

A gold medal for Subbarao

S.S. TARAPORE | Updated on July 26, 2012


The RBI Governor has done well to pick up 200 tonnes of gold in 2009. It would be prudent for the RBI to step up the gold proportion to 33 per cent of total reserves, from 9 per cent.

The international monetary turmoil continues and Nouriel Roubini promises us the ‘Perfect Storm’ in 2013. All the G-20 horses and all the G-20 men couldn’t put Humpty Dumpty together again! Despite the inability of the major reserve currencies countries to deliver international monetary stability, world leaders continue to romance with fiat currency and the maelstrom persists. It would be an affront to admit that an enduring system cannot be developed without gold. Eventually, all countries will have to become slaves of the ‘barbaric relic’.

There is a great divide between precept and practice. While the central banks of reserve currency countries have not bought gold in recent years, these countries hold a large proportion of their international reserves in gold. It is telling that 12 countries hold more than 50 per cent of their reserves in gold.

Raising gold holdings

In recent period, a large number of countries with a low gold proportion in their reserves have bought gold. The move was led by the RBI Governor, Dr D. Subbarao who, in a masterly stroke in 2009, purchased 200 tonnes from the International Monetary Fund ( IMF). The buying of gold by central banks is not a one-off transaction. Many countries are raising their gold holdings — China, Russia, Venezuela, Turkey, South Korea, Thailand Belarus, Slovakia, Ecuador, Mexico, Argentina, the Philippines, Kazakhstan, Ukraine and Tajikistan.

Advocates of fiat currency, who oppose a larger role for gold in the international monetary system, raise the bogey of the threat of deflation as occurred in the 18th and 19th centuries. Since 2007, there has been excessive use of the printing press, which will ultimately lead to an unprecedented world inflation. There are market reports that some leading central banks have discreetly sold in the gold market to moderate the increase in gold prices and, by inference, a depreciation of their currencies.

Pick up in lots

What should India do? At present, the share of gold in India’s total international reserves is around 9 per cent. It would be prudent to build up, over the next two years, the gold proportion to say 33 per cent. Roubini’s storm of 2013 would result in gold prices hitting the roof. Given the sensitivity of the international gold market, it would not be feasible for India to attempt to buy gold in very large quantities.

The international gold price should be closely monitored and the RBI should pick gold on price dips. Of course, the RBI should not go in for systematic investment plans, as this would push up prices against India. As such, there should be random purchases in moderate lots of, say, 10-20 tonnes so as to build up the gold proportion to 33 per cent of total reserves. The intellectual prowess within the RBI would produce formidable studies against increasing the proportion of gold. Good policies do not emanate from such studies, but from instinctive appreciation of the fact that heavy recourse to the printing press must result in depreciation of currencies and appreciation of gold.

As Hayek put it many years ago, created money is like a drug addiction and, once on the drug, the addict needs stronger and stronger doses till an inevitable collapse. Are we in India to stand still with disaster looming all around or are we to protect ourselves as best we can while the international monetary system heads to a morass of confusion and collapse?

Dr Subbarao has already earned his place in the firmament of the RBI by his percipient picking up of 200 tonnes of gold in 2009. If he leads India into the Golden Age, he would rightfully become Zeus in the RBI’s Pantheon of Governors. With the 2012 London Olympics, Dr Subbarao, a reputed marathon runner, should “go for gold”!

Right to create currency

There is another area where the RBI needs to build safeguards in the current international monetary turmoil. Until the early 1950s, the RBI Act provided for a minimum of a 40 per cent foreign assets-currency ratio. In the euphoria of the Second Plan, Dr B. K. Madan, the economic colossus of the RBI, argued for “unfettered right to create currency” to support the Plan. Accordingly, this clause in the RBI Act was abrogated. The rest is history: Punctuated with a series of foreign exchange crises, culminating in the crisis of 1990-91. At present, the foreign assets-currency ratio is 142 per cent.

Given the strong temptation to step up the printing press, it would be desirable to reintroduce, in the RBI Act, a 100 per cent foreign assets-currency ratio. Advocates of unfettered discretion for central banks would no doubt protest that such a clause would imply a Currency Board system. Central banks, the world over, have not been able to use discretion to the advantage of their countries and there is a strong case for a reverting to a Currency Board system. The Financial Sector Legislative Reforms Commission is currently examining all financial sector laws, and it is hoped that the Commission would also examine the issue of legislative restraints on created money.

(The author is an economist. >blfeedback@thehindu.co.in)

Published on July 26, 2012

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