Interest Rates, and Growth…
How stubborn can Central Bankers be? It is surprising – and I am not saying it is easy to be a central banker..just commenting.
Inflation in the US and UK are about 5% – if you ask the people living there (increasing ‘consumer confidence’ is inflation assisted). However the Central Banks are refusing to believe this. With interest rates pegged at 1-2% in both the places, the Central Bank is making a mockery of the ‘smart’ people who ‘saved’ money. Money is losing value real fast – and asset bubbles are getting created ONCE AGAIN…in both these countries.
China holds its currency low, so the Chinese guys who export are INVESTING the money outside (Money is brilliant, it finds the best risk-return avenues). If a Chinese company has exported to Singapore, it buys more properties in Sing rather than bring it to China. Now the average Chinese who cannot do this kind of stuff happily buys gold. Gold here is not an investment – it is a way of saying ‘I do not know what will happen to the yuan’.
Our own RBI CANNOT control inflation, prices of real estate, prices of other non essential commodities. The Government of India is in sleep mode and doing nothing to reduce inflation.
We have a huge supply constraint – 30 years CTC for a house (clearly a bubble? I do not know) or complete failure of infrastructure (5 hour power cuts in parts of the suburbs of MUMBAI) cannot bring the prices below Rs. 90 lakhs for a 2BHK – 40 kms from South Mumbai!!
So at best we can only say what a tough job it is to be the Governor of the Central Bank, do sensible things with your policies, hope that the government will do sensible things, – and talk to the media on a quarterly basis (sounding smart too!),….God…are you listening!!
Sreekant
@ Subra, is there a (sensible) fiscal policy at all? Appalling 🙁 And the only difference is that the Indian surplus forex is borrowed (our external debt just about matches with our forex reserve and then you have FII money also which would drag it to deficit) where as the Chinese reserve is earned and belongs to them (forget its value).
@ Dr Khan, gold standard intrigues me in a way. If (theoretically) all available gold on this planet has been mined and is in circulation, will the world economy just stagnate from that point. Because you have no incentive to expand trade beyond that because its a zero sum game. Only the relative wealth of the gold holders is going to change after that.
@ Pravin, true India’s IT is not just about exchange rate. But do you think the IT companies would stand a sustained rupee appreciation to 30? Just a few years back (2008?) they were all crying over the appreciating rupee. A strong rupee may not be possible in the present scenario of trade deficit.
pravin
@sreekant. yes,if the exchange rate suddenly moves to 30,lots of companies will be dead.the solution is to announce the intention and have a 5-6 year plan to correct the datum.everyone can be prepared.the companies did cry when the rupee appreciated 2 yrs back.but ofcourse they will complain -who will give up 30-40% margins especially if it is subsidized by faulty rupee exchange rate.everyone loves free money
pravin
also,about gold constraining growth -it is a common misapprehension.i’d urge you to read up.gold doesnt constrain growth or trade just as printing paper doesnt make us wealthies.we prosper by making more goods and services available to more people at cheaper prices.
from 1870 to 1913 -the US under a gold standard had a secular deflation of 50% while maitaining a 4% real growth rate per year.and instead of preventing growth,these were the BEST ever years of US growth as a then emerging market.innovation thrived and it was probably the most economically vibrant time in the US history.
pravin
under a gold standard ,prices steadily fall as society reaps the benefit of growth and innovation.some people wrongly say that falling prices will cause harm and prevent people from buying.this is false as we can see people lining up to buy new ipods or PCs even when everyone knows that prices will be lower and features better next year.crashing prices has only helped further innovation and investment contrary to deflation fearmongering.
having gold as the currency,just keeps money honest.suppose you were measuring your weight daily,and the calibration of the weighting scale was changed constantly,would you have comfort in the accuracy of your measurement? gold would keep the weighing scale from not changing.it has no effect on the actual weight of the person.this is analogous to how gold will not have any effect of the actual output.
A return to a gold standard doesn’t necessarily mean that what circulates will be gold. It can very well be banknotes (money substitute). If this is the case, then there will be no problems in accommodating a rise in the demand for money for example.
Sreekant
@ Pravin, interesting info & thoughts about gold standard. Yes evolution of money from barter happened in the environment of restricted availability of goods (like gold today). It is only in the era of fiat currency that growth has started depending more on printing (ask the Americans :-))So logically growth has happened during those days too. But the experience of those 43 years may be too narrow to judge efficacy of gold standard. What would happen over 100 or 200 years?
I also meant circulation of gold based money when I said gold being in circulation. But falling prices of electronic goods may not be an ideal comparison because the fall there is backed by improvement of technology and economies of scale. Look at Japan which has been struggling to grow in an environment of deflation. Psychologically, falling prices leading to lower demand leading to lower production and in turn lower incomes would wreak havoc. Benign inflation does aid economic growth (read recent RBI research which says the threshold for India is about 5.5%). So some amount of printing would become a necessary evil.
pravin
those 40 years was an example -but it combined the most common arguments against gold standard as well as deflation.
the best american growth came with a gold standard and consistent deflation! and yet people are afraid of both.this is strange.
prices were stable for over 200 years in gold terms and the industrial revolution happened under it.so why the skepticism?
the pure fiat money system started in 1971 .it is barely 40 years and yet people are so sure about it?.bizzare
pravin
japan has a debt problem -the problem is not falling prices.the private debt transformed into public debt thru bailouts of useless zombie banks.the engineering and electrical companies in japan are doing wonderfully well and have great cash flow.the japan public debt is over 600% of gdp.their govt is screwed.their businesses are not.their people are doing fine,unless they invested in banks.
so they do have a financial asset meltdown.however their manufacturing and services output is great.productivity is up.
pravin
there is nothing benign about inflation just like there is nothing benign about theft.
infact inflation is a DIRECT tax on the poorest of the poor -those who cant even afford to park their meagre money in a savings account.is the RBI implyging that 5.5% loot of your money is the right amount of theft?
inflation is not uniform.thanks to the fractional reserve system,freshly printed money first enters the system from RBI or govt via banks -who lend it to their favorite big businesses.which bid up the prices of things they want(say steel or coal).this process is not overnight.the prices of things which are bid up first,rise up first -because this is sudden demand.this continues until prices rise for everything.
pravin
i’d urge you to read a)economics in one lesson by henry hazzlitt and b)what govt has done to our money by murray rothbard
i have a CFA (from the US),but i found that whatever economics i learnt in it was an utterwaste and absolutely lacking any explanation of reality.it is mere modeling fantasy.i threw the samuelson/nordhaus economics book out of the window and started from scratch with Hayek and Mises.
the RBI is too steeped in the inflationism policy -totally missing the Hayekian perspective of malinvestment caused by cheap money.
inflationism is a policy which is ok with govt because it helps them keep their votebanks in control.
pravin
please give me a real example of falling prices leading to havoc.we all look for lower prices whenever we shop.we hope prices will be lower and not higher.this is unnecessary fearmongering by people who have not studied monetary history.
yes ,deflation can be bad -IF it is caused by money being sucked out of the system by the central bank.normal innovation and productivity continuosly causes lower prices for everything.this is a great boon to all of us.only the central bank can create dangerous type of deflation (which they did in the great depression)
pravin
some charts to ponder on japan:
Deflation and Output.
Output is high most of the time from 1993-2010.deflation occured ,but not worse than 1%.inflation was low.
http://research.stlouisfed.org/publications/iet/japan/page4.pdf
amol
liked the article and comments…valuable
Sanjay
@pravin :
Falling prices of mortgages create havoc. The recession of 2008 was caused by falling prices of houses in US. I guess same issue was with Japan as well in 1980s.
If tomorrow there are billion ipads and only 100g gold, then Apple would have to be happy with 100g gold in exchange of billion ipads.
Everybody knows that gold is available in limited quantity. That’s why everybody would start hoarding gold. If today I get a apple ipad with 10g gold, I am sure I can buy a bungalow just 5 years down the line with same amount of gold.
All technological prowess would be employed to mine as much gold as possible.
As of now, people are still not doing 100 % investment in gold because it is not a currency. Make it a currency and you would see gold prices soaring every day (even after doing one time adjustment of gold price to make sure that all the gold in the world is matched up with all currency stock in the world; which will anyway increase gold price by million times or more.)
Let me know if I am missing something. I am a novice in economics. But I wont be amused if gold mining companies start increasing gold prices at will just like OPEC (note that oil does have alternative of renewable energy resources; gold would have none because gold will be THE currency.)
Dr Mohammed Ali Khan
@ Sanjay
“Falling prices of mortgages create havoc”
Or is it – “Falling prices cause havoc to mortgages” -because as the value of money increases ( falling prices ) people will be more hard pressed to pay back their debt.
Is this what you mean?
Sanjay
@Mohammad Yes. that is what I meant. Sometimes lenders are more hard pressed than buyers. Sometimes (like in US) I have heard that people who have taken a mortgage loan willfully default.
Dr Khan
@Sanjay
Don’t you see how it makes the whole transaction safer?
In a gold standard, prices will fall because of increases in productivity.
So, taking out a loan will be a risky enterprise. People will SAVE to buy houses, not take out loans. Because of this, there will be less buyers, less demand and prices of houses will correspondingly fall.There will be no overbuilding, no sub-primes, no housing market collapse, no credit crunch and no financial collapse.
The gold standard forces keeps money & therefore people largely honest. Mortgages will be taken by people who expect to benefit from them, for whom the value of immediate cash far exceeds the down payments later – like entrepreneurs and businesses seeking to expand. Resources will allocated more wisely, productively and to people who will extract more value from the loan.
Yes, in a gold standard, growth will be slower, but there will be less booms and hence less busts. Growth will be more sustainable.
But, the power elites of the world are scared of it, because it robs them of a wonderful device(vice?) to steal people’s labour( money is nothing but condensed human labour). They would prefer paper money, money which they can create out of nothing and trade it for our labour, which has value.
If you think about it, you will realize how exploitative and the whole system of fiat money is. That is why they have Nobel prize winning “economists” like Paul Krugman, Keynes and the current idiots who won the Nobel prize for this year to confuse and convince us that
1.Paper money is good 2. There is something called the ‘free lunch’ 3. Bankers are very smart they deserve most of the money 4. Government bureaucrats are smart and they can spend YOUR money better than YOU yourself can!
In fact the Nobel Prize committee always awards the prizes to such ‘ economists’ who with complicated equations and incomprehensible jargon confirm that the above points are correct
Sanjay
@Mohammad :
I agree with you. Government rob us from our savings by introducing inflation. If we make sure that there is no inflation, citizens would be better off. Only government will have a problem because it can not make its debt burden smaller by introducing inflation.
I don’t have much idea of how gold standard works out. I am just trying to guess what will happen if gold standard is introduced.
The point is : What if gold production growth doesn’t match world GDP growth? I guess this is the deflationary scenario everyone is talking about.
To give simple example, I am pretty sure that there would be a growth in food grain output every year but that can’t be assured for growth in gold output. Same thing about real estate and other investments.
How would you make sure that apartment which cost 1kg of gold today will cost the same 10 years down the line? I am sure that there would be too many apartments in the same area. Imagine a scenario where a person says : “My father bought this apartment for 10 lac rupees. Now it costs just 1 lac rupees.”
We make investments in partial need of hedging against inflation. If there is gold standard, everybody will use gold itself as hedge against inflation (Because everybody will guess that after few years gold production will have astronomical cost associated with it).
Even right now, gold doesn’t have utility value and its price is still increasing. Imagine what will happen once gold standard is introduced.
You are right that you cannot trust government but can you trust gold? Wont you find it funny that there would be more effort to create/mine gold than some other useful research.
On hypothetical case :
What I am wondering is this scenario : What if a third world country found a massive deposit of gold – which would be more than deposit of rest of the world – would it be the wealthiest country? Would USA and European country would allow it to be treated as wealthiest country? Even funny thing would be if it decides to keep it as reserve.
pravin
you dont NEED increased gold output for growth @sanjay.
real wealth is creation of goods and services.and not ownership of gold .even under a gold standard.
if a third world country or even USA discovers gold suddenly -guess what happens? just like any good -increased supply of something,decreases its price. gold price will go down.thats it.it doesnt make the gold owner powerful.
“My father bought this apartment for 10 lac rupees. Now it costs just 1 lac rupees.”
um,isnt it how a depreciating asset should operate?
do you say,i bought a car for 8 lacs,but 9 years later it costs only 1 lac if i sell it.prices should fall.
today house prices rise ONLY because of inflation and not because of some inherent nature of real estate.in fact,a 9 yr old house needs more maintenance,has wear and tear -in a non inflationary world,assuming building technology has improved in 9 years,it should be cheaper to build houses now than earlier.why should anyone pay high prices for an old house? it is telling how we always assume that house prices should keep going up.just tells us how inherently attuned to inflation we all are today.
considering that under gold standard,inflation was close to zero for over 250 years,i fail to understand your sudden fear that gold prices will keep going up.
i guess that you have not bothered to read about the gold standard (you wouldnt be alone,sadly) and all your statements/fears are either based on a wrong understanding of gold standard or a misunderstanding of the role of money
pravin
here are the reasons gold has been considered to be money for millenia.
a)it is rare and scarce,but is available and the 100g scenario is meaningless.humanity has settled on gold
because it is in ‘just the right’ quantity
b)it cannot be diluted,it is safe(that is why we dont use plutonium or uranium)
you have to study how gold as money evolved: first we had barter,then to take advantage of division of labor,we chose stuff like salt,cowrie shells,cattle etc as money.it was after 6000 years of trial and error that we settled on silver and gold.
pure paper is just 40 years old.and it based on the arrogant idea that govt can control our lives and the path of the economy.
this arrogant idea will crash sooner than later.it has happened to all experiments with paper in the past.this time is no different