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Gold Threatens Government Monopoly

Written By Geoffrey Pike

Posted November 30, 2015

goldscamOne of the new Indian gold schemes is being hailed as a success by government officials, saying they received 63,000 applications for the paper gold investment.

I have been following a couple of gold schemes introduced by the Indian government that seek to reduce imports of gold. Despite an import duty on gold, the country still imports nearly 1,000 tons annually.

You may wonder, why would the government want to reduce gold imports? According to the government, it wants to reduce the large trade deficit. A more logical explanation is that the government hates the competition with its money. Governments like monopoly power, and gold threatens the government’s monopoly over the money supply.

While India is something of a third-world country, it is a third-world country with well over a billion people. And despite the widespread poverty, there is a significant amount of wealth there. Due to its history and culture, along with a distrust of the government’s money, gold is a very popular commodity to own in India.

In our global financial world, India does not have a great effect, despite the large population. Again, it is relatively poor. China has grown much faster in terms of economic growth, and the Chinese economy impacts the worldwide economy to a much greater degree now.

With that said, if there is one specific area where India does have an influence in world prices, it is gold. There is great enough demand coming out of India to really affect global prices. The question right now is whether these new government gold schemes by the Indian government will have any significant impact on gold prices.

The initial reports state that 63,000 applications were received for 917 kg of paper gold. This would be worth about 246 crore, which is 2.46 billion rupees. Overall, we are talking less than $40 million, which is a relatively small sum.

The Indian government is basically selling gold bonds. An investor must by a minimum of 2 grams, with a maximum of 500 grams. The gold bonds are all in multiples of 1 gram. There is a fixed annual interest rate of 2.75%, with the possibility of capital gains if the price of gold goes higher. These capital gains will, of course, be taxed.

The gold bonds will have a maturity of 8 years, with an option to exit after 5 years.

Trust Us, We’re the Government

There is a saying that, “There ain’t no such thing as a free lunch.” This isn’t always literally true. When it comes to the government, it is true. Or to be more precise, if someone is getting a free lunch, then it isn’t free for somebody else who isn’t even getting the lunch.

If these initial reports are accurate, it is quite astounding that 63,000 people would be willing to invest in gold via the government. If we look at the glass being half full, we can say that this isn’t a large number in comparison to the over 1.2 billion people living there.

We also don’t know the situation of these investors. Some of them could already own physical gold and are just looking for some diversification. Hopefully none of them are selling their physical gold to invest in these government gold bonds.

The maturity dates should make any investor nervous, especially when dealing with a legal system and government that have not been the best at upholding property rights.

This means that anyone invested in these bonds will have their money tied up for at least 5 years. That is a long time to wait, especially when dealing with politicians that can change the rules of the game at any time. It is a long time to wait when the economy can change within days.

We know how the U.S. government operates. Just look at Social Security. The money is collected by current workers to pay retirees. The money that workers pay into the system now is not saved. The whole Social Security Trust Fund is made up of a bunch of government IOUs. The money has been spent.

Should we think the Indian government will be any different? What will the government do when it collects money from its sales of gold bonds? Is anyone naïve enough to think that the government will buy a bunch of gold and store it?

The sales from these gold bonds will be used by the politicians for current expenditures. In 5 or 8 years when investors are looking to redeem the principal on their gold bonds, the government will deal with that problem at that time.

But what if times are really tough and the government just doesn’t have the funds to pay back the bond holders? Are these investors certain that previous promises won’t be broken?

I think these investors are crazy to trust the government with their money. It is somewhat disappointing coming from India, as owning physical gold is one of the great attributes of the Indian culture. It shows a healthy distrust for the government and its funny money.

The excuse of reducing the trade deficit is just that. It is an excuse. The real reason the politicians want this to be a successful gold scheme is so that they will have more money to spend.

Overall, I don’t think this is going to have a significant impact on gold prices. The large majority of Indians with any significant amount of wealth are still going to look to own physical gold over any government gold bond scheme.

Still, I hope for the sake of the Indian people that this gold scheme is a failure. The politicians are playing tricks on people to hand over their money. It is a big mistake to trust the government. This will turn out to be something of a Ponzi scheme, similar to the way Social Security has been run in the United States.

At least the Indian gold bonds are voluntary – for now anyway.