There has been an unprecedented surge of gold imports into both India and China in 2011 and this is likely to continue in the future. Pure economics cannot explain why these two traditional societies are importing gold on such a massive scale. Just look at the numbers: India and China together are incrementally buying nearly 45% of all gold being produced globally and, if imports continue at the present rate, the two societies could end up consuming up to 70% of the yellow metal in the years to come. India?s annual imports, at over 900 tonnes, are marginally higher than China?s. But China, essentially coming off a lower base, has shown gold import growth of over 400% in recent months.
India could be importing gold worth about $55 billion by the end of this fiscal, a 60% rise over the gold imported in 2010-11. In fact, such a massive surge in gold import is being seen as a problem by policymakers, especially in the current context of rising current account deficit putting pressure on the rupee. If gold imports had been normal, like what was seen in the earlier years, India would have saved over $25 billion of foreign exchange this year, thus virtually halving its current account deficit, which may touch 3% of GDP in 2011-12.
So, the policymakers? dilemma is whether to discourage imports of gold, which is seen as a non-productive asset in the short run. It just sits in the vaults of households across the country. Indian households could possess gold worth $1 trillion in a few years. Why waste so many precious dollars on gold when the dollars are needed for other critical imports such as oil and other forms of energy. The question might appear valid from the standpoint of rational economics. But then economics in recent years has ceased to be all that rational.
Well, if you believe in the market forces, then you must allow people to import whatever they want. If it is gold, so be it. Interestingly, the larger psychological motivation behind the unprecedented rush of gold imports into India and China could be similar.
In the short to medium term, people are buying gold as a hedge against the sticky global inflation fuelled by unprecedented injection of liquidity (printing money) by the central banks of the developed world since 2008. The European Central Bank is currently in the process of printing more money to provide European banks much-needed liquidity to avert a sovereign debt meltdown. Such heavy liquidity injection is causing a sort of scare among investors who feel no asset class is safe today except gold. There is volatility in equities, debt, oil and other commodities. Somehow, there is faith in gold because it is the only asset class that withstood the ravages of the 2008 global financial meltdown and continues to give returns to investors.
For ordinary Indians, gold gave a return of 33% in 2011 compared with negative returns in all other asset classes. So there is evermore faith developing in gold as an asset class.
Of course, there are Cassandras who have been warning that the rise in gold prices will not sustain for long and a big correction could happen any time. However, so far, gold is way ahead in the marathon among all asset classes. The Chinese central bank is also buying massive amounts of gold, partly as a hedge against the US dollar, which is generally perceived to be in decline over the longer term. In the past few years, most emerging market central banks have increased the weight of gold in their forex reserves.
Clearly, gold has emerged as a long-term panacea in the consciousness of the two most populous emerging economies of the world with 3.6 billion people. I still recall how some years ago a woman implored a politician during an assembly election meeting in Tamil Nadu that the government must make gold more affordable!
Over the past 11 years, gold has risen from $280 per ounce to $1,920 per ounce. It has outperformed almost all other asset classes during this period. John Maynard Keynes had famously described gold as a barbarous relic of the past. However, social scientists would tell you that humans feel a deep urge, from time to time, to return to their ?barbarous past?. This, in part, may explain why gold continues to have such huge traction in traditional societies such as India and China.
There are also scientific explanations why the world tends to seek refuge in the yellow metal from time to time, especially in times of crises when confidence in established currencies decline. Historically, there is a direct correlation between irresponsible economic governance around the world and the rallying in gold prices. As long as there is continued growth in global money supply, without concomitant increase in productivity, the yellow metal will keep rearing its head. This phenomenon is clearly in evidence since the 2008 financial meltdown on Wall Street and the massive liquidity support given to banks by printing currency.
Irresponsible economic and monetary governance is nothing new. It has happened with remarkable frequency, thus lending further credence to the yellow metal. Forty years ago, US President Richard Nixon got ambitious and jettisoned the gold-backed system of currency partly because he wanted to be able to print unlimited dollars to fund wars outside the America and to feed the military industrial complex. So, Nixon ushered in a new era of floating ?fiat currency? that was not linked to gold. This move was justified in the name of migrating to a more modern system of currency management. Being linked to gold was seen as ?primitive?. This narrative continued for decades later as central banks in the West declared that gold had become a thing of the past and that the dollar had indeed replaced gold for all times to come. Such was the passion associated with this thought process that the central banks of the developed world had started offloading the gold kept in their reserves for decades. The same central bankers are now scurrying to buy more gold! How can they ignore the manner in which China and India are consuming gold today? When America departed from gold standard (1970), an ounce of gold then was valued at $36. The same ounce of gold is over $1,600 today. That tells you the story of the dollar’s debasement over the years. Indeed, printing limitless money may become an even more endemic as the US and EU go into a long-term low-growth trap.
Therefore, the larger, and indeed futuristic question, to ask is whether India and China will accumulate so much gold over the next decade as to force the world to go back to some form of ?gold standard? practised in the past. The future, as they say, may be derived from the past!
mk.venu@expressindia.com