Even though the gold contract has broken through the Rs 30,000-barrier, we still hear of statements from some of the country's bankers and government officials discouraging people from investing in Gold, calling such a saving 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, such comments demean the smart Indian masses who know how to preserve whatever little wealth they have than most of their Western counterparts.
Save now, consume later
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 such as oil, labour, food, etc. These resources 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 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, calling gold investment a ‘wastage' is 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 determine the popularity of the saving asset is that it should neither be abundant nor too scarce and whose quantity can't be increased at will. Gold pretty much fits the bill.
By investing in gold, Indians have been able to preserve their wealth from the government's constant financial repression. Doing so is not a waste of national wealth but a preservation of individual wealth
Forex reserves
Let us now take up the second reason for gold bashing: gold leads to a loss of precious forex reserves.
Granted, that since India imports its entire gold needs, there is an argument, at least on the surface, against loss of forex reserves due to gold. However, it is a superficial way of looking at things. Loss of forex reserves is a natural market phenomenon in the current economic context and gold just acts as a medium for that.
There is only one way for the runaway inflation to come down — by reducing the credit growth in the economy. This can be achieved without compromising growth if the government is able to reduce its penchant to spend taxpayers' money without any improvement 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 any RBI intervention through OMOs 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. This would, however, 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.
Wealth preservation
So, by investing in gold 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 in the form of higher interest rates and forex outflows.
Lastly an argument can be made that instead of gold, money can be put in stocks. While stocks are surely a good medium to save one's wealth, unlike gold, the supply of stocks can be changed by a keystroke.
More importantly, 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. 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 gold intermittently (during periods of increased private sector credit growth and low inflation) ultimately they revert to the trend line set by gold (during periods of credit slowdown or high inflation). So investing in gold is a way of correcting the economic follies of the government.
Sure, the reduction in credit growth does hurt the profitability of banks and that's why they have every right to oppose investing in this metal. Their profits are transferred to the bullion investors.
(The author is an independent financial consultant at Random Chalice Financial Research, Delhi. The views are personal.)