The reason why the gold prices are galloping
By Dr Bharat Jhunjhunwala
It will be plainly understood by the reader that the value of the paper on which a 1,000-rupee note is printed or the paper on which a cheque of Rs 1 crore is written is scarcely 1 paisa. Or the value of the paper on which a property valued at Rs 10 crore is registered maybe only a few lakh. The value of these papers arises from the backing of the matter written thereon. The 1,000-rupee note is valuable because the Reserve Bank of India guarantees to redeem it. A cheque is valuable because the bank is ready to honour it. The document of a property is valuable because the police is committed to restore possession of the owner. It will be clear from the foregoing that value of a currency arises from the ability of the central bank to back it with real assets.
The American dollar was backed by the US government in this manner after the Second World War. The American Federal Reserve Bank guaranteed that it would provide an ounce of gold for 35 dollars to anyone who demanded this. In this situation it was profitable for people to keep their wealth in form of dollars instead of in gold. They could deposit the dollars in a bank and earn interest on it. They could withdraw the dollars from the bank and convert them into gold whenever they wanted. Keeping wealth in form of gold did not earn interest. This was the reason that the dollar acquired the status of the "world currency".
The situation changed dramatically in 1971. Oil-producing countries of West Asia formed a cartel by the name of OPEC and raised the price of oil overnight from about $1-2 a barrel to $11. Subsequently, they raised it to about $21 a barrel. The American economy started feeling the pressure of expensive oil. People were worried whether the Federal Reserve Bank would be able to honour its guarantee of exchanging 35 dollars into an ounce of gold. There was a run on the dollar. This forced the Federal Reserve Bank to withdraw the guarantee. The gold standard was abandoned. The dollar was no longer freely convertible into gold. This was the beginning of the end of dollar supremacy. The writ of the dollar continued, however, because the United States accounted for more than one-third of the global economy at that time.
The US economy began to crumble in the nineties in large measure due to the wars in Iraq and Afghanistan. The American government did not have the money to wage these wars. American people also did not have the income to consume goods produced by rest of the world. America adopted Charvaka’s dictum: "Borrow and drink ghee." The Federal Reserve Bank sold US Treasury Bonds in large quantities to raise moneys for the wars and for consumption by the American people.
Coincidentally, China was seeking modern technologies at the same time. China invited American multinationals to come with frontline technologies and establish manufacturing facilities in China to produce goods for exports to their home country. China provided these multinationals with cheap labour having virtually no protection of labour laws and cheap electricity and minerals. The multinationals exploited these cheap resources and exported goods to America. The problem was that America did not have the money to pay for these imported goods. China stepped in and started buying US Treasury Bonds. China provided the money to America to buy Chinese goods much like automobile companies provide loans to buyers. America sold US Government Treasury Bonds and bought goods from China and waged wars on Iraq and Afghanistan. In the last decade, this led to China accumulating US Treasuries to the tune of $1,400 billion. This accumulation of US Treasuries was okay as long as the US economy was strong.
There were limits to this policy of borrowing for consumption, however. Last two years have seen this truth dawning upon global investors including China that the US was living beyond its means. Most expect the dollar to decline further. Investors stopped investing in dollar-denominated assets. The extent of decline of the US economy can be gauged from the fact that the price of gold has increased from $35 to $1,000 an ounce between 1971 and 2009.
This decline of the US economy is not clearly visible today. The dollar has risen against the rupee, for example. Four years ago, the price of a dollar was Rs 40 as against Rs 48 today. But this is deceptive for two reasons. One, the Indian rupee has decline parallel to the dollar because the Indian government has been as profligate as the American government. Both are declining as two persons holding each other drown in the river together. Secondly, American companies have brought back investments made by them in foreign countries after the crisis has struck at home. This inflow of dollars is temporarily pushing up the value of dollar against other currencies. The rise in dollar against the rupee, therefore, does not cancel the long-term decline in the dollar, which is plainly visible in the steep increase in the price of gold since 1971.
The decline of the dollar has removed the only 'safe' storehouse of wealth. The dollar was considered safe in the last 60 years after the Second World War. The value was reduced to one-half upon abandonment of the gold standard in 1971. The American economy continued to dominate the world, however, because it was the largest and technologically most advanced. The remaining value of the dollar has declined in the last two decades, in part, because of the wars launched by that country. The global investors are reluctant to invest their money in dollar-denominated assets like US Treasury Bonds, property in Manhattan or shares of US companies because the future of the US economy and value of the dollar are no longer stable. My assessment is that the world economy will face another crisis, perhaps worse than the present one, in the coming two-three years. The US dollar, European euro and Japanese yen will all crumble because the high wages of these economies are no longer sustainable against the high-technology low-wage combination wielded by India and China.
The global investors are today looking for an alternative storehouse to keep their wealth. They want to exit the dollar, euro and yen. This alternative storehouse they are finding in gold. Thus, the price of gold is likely to increase more in the near future. There may be a temporary decline for a year or so as the Western economies grow on the back of the stimulus packages. But this façade will collapse as soon as the time comes to pay for the stimulus packages. Therefore, gold is likely to shine in the times to come.
to say something.Amazing logic indeed, this is a crazy world!*Interesting article written by an Indian Economist. *Japanese save a lot. They do not spend much.Also, Japan exports far more than it imports.Has an annual trade surplus of over 100 billion. Yet Japanese economyis consideredweak, even collapsing.
Americans spend, save little.Also, US import more than it exports.Has an annual trade deficit of over $ 400 billion. Yet, the American economyis considered strong and trusted to get stronger.But where from do Americans get money to spend?They borrow from Japan, China and even India.
Virtually others save for the US to spend.Global savings are mostly invested in US, in dollars.India itself keeps its foreign currency assets of over $ 50 billion in US
securities.China has sunk trillions of dollars in US securities.Japan's stakes in US securities is in many billions.
*The Result: * The US has taken over $ 5 trillion from the world.So, as the world saves for the US, Americans spend freely.Today, to keep the US consumption going, that is for the US economy to work,other countries have to remit $ 180 billionevery quarter, which is $ 2 billion a day, to the US !
A Chinese economist asked a neat question.Who has invested more, US in China, or China in US?The US has invested in China less than half of what China has invested in
US. The same is the case with India. We have invested in US over $ 50 billion,but the US has invested less than $ 20 billion in India.
*Why the world is after US? *
The secret lies in the American spending, that they hardly save. In fact,they use their credit cards to spend their future income. That the USspends is what makes it attractive to export to the US.So, US import more than what it export year after year.
*The result: *The world is dependent on US consumption for its growth. By its deepeningculture of consumption, the US has habituated the world to feed on US
consumption. But as the US needs money to finance its consumption, theworld provides the money.It's like a shop-keeper providing the money (credit) to a customer so that
the customer keeps buying from the shop.
If the customer will not buy, the shop won't have business,unless the shopkeeper funds him. The US is like the lucky customer. And theworld is like the helpless shopkeeper financier.
Who is America's biggest shopkeeper financier?
Japan of course.Yet it's Japan which is regarded as weak. Modern economists complainthat Japanesedo not spend, so they do not grow.To force the Japanese to spend, the Japanese government exerted itself, reducedthe savings rates, even charged the savers.
Even then the Japanese did not spend (habits don't change, even with taxes, dothey?).
Their traditional postal savings alone is over $ 1.2 trillion,about three times the Indian GDP. Thus, savings, far from being the strengthof Japan, has become its pain.
Hence, what is the lesson?
*That is, a nation cannot grow unless the people spend, not save. Not justspend, but borrow and spend. *
This the new theory of economics has evolved
Dr. Jagdish Bhagwati, the famous Indian-born economist in the US, toldManmohan Singh that Indians wastefully save.
Ask them to spend, on imported cars and, seriously, even on cosmetics!
This will put India on a growth curve.This is one of the reasons for MNC's coming down to India, seeing theconsumer spending.
'Saving is sin, and spending is virtue.'
But before you follow this neo economics, get some fools to save so that
you can borrow from them and spend !!!
Regards
Dr. P.R.Subas Chandran, Ph. D
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