There are two gold schemes being implemented by the Indian government. They are being pushed in a supposed attempt at reducing gold imports in order to reduce the trade deficit.
One of the plans involves having temples turn over a portion of their gold to banks to earn interest. This would involve jewelry being melted down and converted into gold bars and coins. This is sometimes referred to as the gold monetization plan.
The other plan involves a new investment vehicle called a sovereign gold bond. These bonds would be available to Indian citizens and would represent a certain denomination in gold: 5 grams, 10 grams, 50 grams, or 100 grams.
They would be bought for a certain time period and would pay interest similar to a bond. The difference is that an investor would profit or lose based on the price of gold from when the bond is bought versus when it is sold.
A recent report by Nomura, a Japanese financial firm, analyzed the likelihood of success of the two plans. The report states that the sovereign gold bond scheme has a better chance of succeeding than the gold monetization scheme.
For the gold monetization scheme to work (in the eyes of the Indian government), households and temples would have to turn over their gold. This presents a major challenge in a country where the people value gold probably more than any other tangible thing.
Why would a household that owns gold decide to turn it over to the government? Is a little bit of interest enough to entice people? This would defeat the purpose of owning gold for confidentiality, and it would also bring on unwanted tax scrutiny.
And can the Indian people really trust their government with their gold? Again, that is one of the main reasons to own gold. It is because of a lack of trust in the government. How can anyone be sure they will get it back?
The Nomura report was probably right in that the gold bond scheme will have a greater chance of success for the bureaucrats. This would attract more investors who may or may not actually own physical gold. But it wouldn’t involve turning in already-owned gold for the investor.
Of course, this investment is madness too, but it wouldn’t be quite as surprising to see some people fall for it. When you buy one of these bonds, is it really backed by gold? Or is it just backed up by the Indian government’s promise to pay you back what you are owed?
If there are no dramatic moves in the gold price, then the Indian government will probably make good on its promises. But if the gold price were to double or triple in the matter of just a couple of years, what is preventing the government from just declaring that it can’t afford to make good on its promises to investors? If it doesn’t own the gold to back it up, then it is just a meaningless political promise. Even if the bonds were fully backed by gold, I would still be skeptical.
Government Interference and Intentions
The Indian government says it is trying to reduce its massive trade deficit. They are blaming this on the big gold imports due to the high demand for gold inside India.
The bureaucratic Indian government has already placed heavy taxes on gold imports in an attempt to reduce demand. This just encourages the underground market to flourish in an attempt to meet demand. It doesn’t matter if it is drugs, weapons, or gold. If you make something illegal or really expensive, then underground markets will attempt to fill the void.
The politicians will only create more problems and distortions with these gold schemes. The “problem” of the trade deficit is not something the government should be fixing except in that it should stop running budget deficits.
If the government isn’t running up debt, then a trade deficit doesn’t matter. It is a misnomer anyway. There is no trade deficit. It is not as if the Indians are giving things away and getting nothing in return.
If anything, it would be the other way around. The Indians are actually getting gold imported into the country. It is the precious metal that has thousands of years of history for its value. It is used for industrial purposes. It is used for its beauty in jewelry. Most importantly, it has a history of being used as a form of money.
If the Indian people want to give up fiat currency or other goods and services in exchange for gold, why is this such a bad thing in the eyes of the Indian government? Perhaps the politicians and bureaucrats know that owning gold is symbolic of not trusting the state.
Unfortunately, the general population of India is ignorant of economics if the government is any indication of popular opinion. It is a massive welfare state with bureaucracy and red tape crushing the entrepreneurial spirit.
But if there is one thing that is widely understood in the Indian population, it is the importance of gold. They revere its beauty, and they also trust it over their government.
When it comes to owning gold, the Indian people are much smarter than the American people as a whole. Because the U.S. dollar has been somewhat more reliable, it has fooled most Americans into trusting their own government and the fiat currency that goes with it.
I don’t think the Indians are going to fall for these latest government gold schemes. If the U.S. government tried something similar, it might have a better chance of duping investors.
