A popular phrase in segments of the mainstream financial media is that “You Can’t Eat Gold”. We don’t know who first uttered this comment, but it was more than likely a talking-head or Wall Street analyst on CNBC or Bloomberg.
The disparaging claim seems to be based on concluding that in a financial or monetary crisis, if you own gold, that “You Can’t Eat It”. And so, according to the logic of whoever came up with the phrase, this would make gold useless during a financial crisis.
In addition to the misleading and irrelevant nature of the comment, which we will discuss below, the claim that “you can’t eat gold” is actually factually wrong. And that is because you can eat gold. And also drink it.
Eating and Drinking Gold
While gold can be eaten, it cannot be digested. But it is non-toxic to the human body. And it does not react chemically in the human body. That is why gold can and does appear safely in a number of foods and drinks, not surprisingly foods and drinks which are predominantly at the luxury end of the market.
Some readers will have heard of Goldschläger, a Swiss/Italian liquor which has flakes gold suspended within it. On a similar note, a Swiss gin called ‘Studer Swiss Gold Gin’ also contains flakes of gold. Staying within Switzerland, you can also buy edible gold products including “Swiss chocolate truffles with gold flakes”. Not to be outdone by the Swiss, the Emirates Palace Hotel in Abu Dhabi (United Arab Emirates) offers a ‘Palace Cappucino” which is sprinkled with gold flakes.
In Selfridges department store in London, you can buy a “billionaires soft serve” ice cream cone topped with both sprinklings of gold leaf and a gold leaf covered flake. While in New York, in Manhattan’s Upper East Side, a high-end restaurant offers a "Golden Opulence Sundae” topped with gold leaf, for US$ 1000 a glass. Back in England, a specialist cheese producer in Leicestershire created Britain's most expensive cheese - "Clawson Stilton Gold", a stilton cheese interwoven with edible gold leaf and shot-through with gold liqueur. These uses of gold in food and beverages illustrate that gold is a sought after and prestigious substance, but also that gold is real, that gold is tangible and that gold is of value.
Wall Street's Selective Focus
The logic of the “you can’t eat gold” comment, as well as being wrong, is also flawed. Because by extension, you can’t eat any of Wall Street's favorite investment assets. Imagine chewing on financial securities or fiat currencies. But whoever coined the phrase “you can’t eat gold” conveniently failed to mention this on CNBC. We would challenge anyone, especially CNBC and MSNBC, to eat share certificates or bond certificates or the electronic equivalent thereof.
Nor can you eat the electronic coins of cryptocurrencies such as Bitcoin, Ethereum’s Ether or Litecoin. Real assets such as art, antiques, real estate, agricultural land, or vintage cars are also off the menu. A possible exception is that can drink an expensive investment wine collection, but would you really want to do this, as then you would be consuming your principal investment?
Gold's Many and Varied Benefits
But beyond the fact that you can in fact eat gold, and that Wall Street never points out the non-edibility of stocks and bonds, there are many beneficial reasons to buy and own investment grade physical gold of which we recently pointed out in 28 reasons to buy and own physical gold. What we are talking about is real physical gold in the form of gold bars and gold coins. This is true both during times of financial crisis, and also over the long-term as a form of investment and savings.
Gold is without doubt the ultimate safe haven asset. In times of financial crisis and turmoil, investors and savers flock to gold as a wealth preservation strategy. The reason for investing in gold during times of crisis is based on the fact that investors instinctively know that the gold price behaves differently to the prices of other assets, particularly during crises. This is because the gold price moves independently of economic and business cycles.
In times of war and social upheaval, physical gold's benefits also come to the fore. Since gold has a high value to weight ratio, significant personal wealth can discreetly be carried in the form of gold across borders and frontiers and within areas of conflict.
Since gold is a universal money supported by a highly liquid global market, it will always be accepted everywhere at the going gold price. Gold can easily be sold. Gold can easily be traded or even bartered with, especially in non-functioning economies where the local paper currency has collapsed or has become worthless. The fact that gold coins are regularly issued to elite military personnel in areas of conflict attests to gold's critical benefits in times of monetary crisis and localized economic collapse.
Gold as Store of Value
But gold is not just of use during financial crises. It is also an essential asset to own over the long-term as a strategic form of saving and investment. Physical gold retains its purchasing power over long periods of time. This is in contrast to fiat currencies issued by the world's central banks, which generally lose most of their purchasing power over time. In other words, gold is a great hedge against inflation, as the gold price adjusts upwards to offset inflation. The gold price even adjusts to inflation expectations, hence it is sometimes called an inflation barometer and is watched like a hawk by central bankers because the gold price signals future inflation.
Physical gold is also an asset without counterparty risk. This is because when you own physical gold in the form of gold bars or gold coins, there are no counterparties. In other words, the physical gold that you own outright is no one else's liability. Nor are there any governments or central banks involved in issuing gold, or in trying to increase and debase its supply. Gold also lacks default risk, because it cannot default.
Physical gold is also inherently valuable because it is a scarce precious metal that is difficult and costly to mine and refine. Gold's price will never go to zero because it has a finite and significant production cost. Physical gold is difficult to counterfeit, impossible to create artificially, and cannot be debased.
These are just some of the reasons for buying and owning physical gold. Please see BullionStar's recent article"28 Reasons to Buy Physical Gold" for a list of reasons why you should consider buying physical gold.
Gold in Zimbabwe & Venezuela & South Korea
In the real world, owning physical gold can be of critical importance in scenarios where trust in a nation's money supply has evaporated, such as is currently the case in Venezuela or Zimbabwe.
Gold can also be of critical importance when entire nations suffer economic shocks. A case in point is the interesting experience of South Korea during the Asian financial crisis that swept the region in the late 1990s. This crisis left the South Korean economy severely impaired, with it’s currency, the Won, collapsing against the US dollar.
In addition to a bailout by the International Monetary Fund, the South Korean government also launched a patriotic campaign in early 1998 to actually collect physical gold from the South Korean citizens which was then sold on the international market to raise much-needed foreign currency. This collective campaign was pursued precisely because the South Korean government understood that gold is a high-quality liquid asset that has substantial value.
National Mobilization of Gold
By mid-March 1998, the South Korean citizenry had donated more than 220 tonnes of gold, worth over US$2 billion, in the form of investment gold coins and bars, and other gold in the form of rings, jewelry, and gold medals. More than 3 million households were said to have contributed. This collective mobilization of gold to overcome a nation's economic adversity and raise financing is a great illustration of how gold comes to the fore in a time of crisis, due to its store of value, safe haven, and high liquidity characteristics.
In conclusion, knowing the many compelling reasons to buy and hold gold, and how gold can sometimes be a lifeline in a time of crisis, the claim that "you can't eat gold" is exposed for what it is, misguided and disingenuous, and shows either ignorance on the part of the people who use it, or more likely, a deliberate intention to mislead and deceive.
When a nation adopts a foreign currency it will typically face significant hurdles when it tries to rid itself of that currency, or de-dollarize. But Zimbabwe’s autocratic ruler Robert Mugabe has appeared to have done the impossible. After dollarizing ten years ago, over the course of the last year or two he and his cronies have managed to throw off the U.S. dollar and re-introduce a Zimbabwean replacement.
We can see evidence of this new currency in Zimbabwe's stock market. Below I've charted the country's main equity index, the Zimbabwe Industrial Index, going back to 2011. What an incredible rise over the last year, right? Beware; these returns have nothing to do with real economic growth. Zimbabwean equities have switched from being claim on an a stream of cash flows denominated in U.S. dollars to a stream denominated in Zimbabwe's new currency. Because investors expect inflation of the new currency to drive up future cash flows, they have responded by bidding stock prices up. In real terms (i.e. U.S. dollar terms), stock prices are probably flat–and may have even declined.
Dollarization and de-dollarization
Let's back up a bit. For those countries that mismanage their currency, the penalty box has typically been some form of dollarization. The citizens of a nation grow so tired of the hyperinflating currency that they opt for an alternative, whether that is euros, dollars, or some other medium of exchange.
Dollarization is usually only partial, the mismanaged currency continuing to circulate–albeit to a lesser extent–in conjunction with a stable alternative. Zimbabwe is unique in being one of the few countries to fully dollarize. By late 2008 the hyperinflation of the Zimbabwe dollar had become such a burden that Zimbabweans–without the permission of the Mugabe regime–threw their local currency notes into the gutters and adopted the U.S. dollar as their sole medium of exchange and unit of account.
In 2016-17, the reverse has happened. Before I go into how the new Zimbabwean currency was introduced, it should be emphasized how difficult it is to replace an existing currency with a new one. Currency usage is locked in place by tradition and broad acceptance. Even when a national currency is doing very poorly, any single individual will be loath to be the first to desert it for a more stable alternative. Money is only useful when many people are using it, and since any new money lacks a base of users, it faces the paradox that it cannot ever get jumpstarted. In the case of modern Zimbabwe, the communal benefits of using the U.S. dollar as the "language of trade" are significant, so any alternative should have faced a huge hurdle in gaining acceptance.
The birth of Zimbabwe’s new currency
That the new Zimbabwean currency managed to make it past this hurdle is a testament to the powerful combination of subterfuge, brute force, and good old Gresham's law that overpowered the staying power of the U.S. dollar. What follows are the steps that led to this switch.
After the 2008 dollarization rendered it useless, the Reserve Bank of Zimbabwe (RBZ) sneakily got back into the money printing game in 2012 or 2013. Creating a new national currency from scratch would have been politically impossible; the population was still furious with its leaders' previous monetary mistakes. So instead the central bank began issuing a U.S. look-alike. Domestic banks had the option–and later were required–to open U.S. dollar accounts at the RBZ. These accounts weren't available to the public but could be used between banks to settle domestic payments flows. At first, the RBZ's U.S. dollar deposits were as good as the real thing. Banks could easily convert them into U.S. paper currency.
As time passed, Robert Mugabe's government drew down on the RBZ's resources in order to fund a massive spending campaign. This depletion of the RBZ's hard currency reserves eventually forced it to renege on its promise to commercial banks to redeem in dollars. Regular Zimbabweans only got their first sign of trouble in early 2016. Since commercial banks could no longer rely on the RBZ to convert its U.S. deposits into real U.S. cash, the banks had no choice but to pass their inability to get cash on to their customers. The ability of the public to withdraw cash from U.S. dollar accounts was steadily cut back until they could only take out $50 per day, leading to massive lineups at banks across the nation. With the convertibility promise having been betrayed, dollars held in the banking system ceased to be equivalent to U.S. dollars. They began to trade at a 5-20% discount to genuine U.S. cash in the black market.
In November 2016 the RBZ introduced the bond note, its first issue of paper money since the old Zimbabwe dollar had expired worthless in 2008. (For more details, read my post on the topic here). As in the case of the accounts at the central bank, bond notes were supposed to be redeemable on demand into U.S. dollars. But this redemption promise proved to be a sham–and bond notes quickly began to trade at a discount to U.S. paper money.
Gresham’s law makes an appearance in Zimbabwe
Having duped the population into accepting RBZ-issued dollar notes and deposits, the government proceeded to declare its new currency legal tender. This meant that any creditor who had lent out U.S. dollars was obligated by law to accept payment in bond notes at par. At the same time, the authorities required retailers to treat all payments media as equivalents–they could neither discount the inferior currency nor accept the superior currency at a premium, the penalty being seven years in jail.
Which gets us to Gresham's law. A rule going back to medieval times, Gresham's law tells us that when a government dictates the exchange rate between different types of money, the 'good', or undervalued money will be chased out by the 'bad', or overvalued money.
To see how Gresham's law has played out in Zimbabwe, consider a Zimbabwean street hawker who prior to 2016 had been selling oranges for $1 per bag. The new Zimbabwean currency is introduced. Because this new currency is inferior to the U.S. dollar, the street hawker continues to charge $1 per bag for those paying with genuine dollars but requires everyone paying with new currency to pay an extra 50 cents, or $1.50. With this new dual-pricing scheme, some customers will continue to pay with U.S. dollars, others will pay with bond notes. Both types of money circulate together.
When the government announces that all currencies must be treated as equals, the street hawker can no longer charge an extra 50 cents to those paying with Zimbabwean currency. To meet the letter of the law, he sets his price at a flat $1.50 per bag of oranges, irrespective of the type of currency used. However, this undervalues the U.S. dollar. After all, $1.50 in U.S. cash should be capable of buying a bag-and-half of oranges, not just one bag. The result is that none of the street hawker's customers will ever pay with U.S. dollars, preferring to hoard them and proffer Zimbabwean currency as payment instead.
This parable of the street seller has occurred all over Zimbabwe over the last twelve months. Thanks to the government's edict that all currencies be treated as equals, U.S. dollars have been driven entirely from circulation. No one wants to use them because they are undervalued. As a result, bank money and bond notes have become the main media of exchange in Zimbabwe. Zimbabwe has dedollarized.
Prices are on the rise. I used the stock market as an illustration of this in my introduction. Consumer goods have been slower to adjust, but earlier this month Equity Axis–a local financial research firm–reported that the prices of basic goods have gone up by between 50- 100% over the past eight weeks. On the streets, illegal currency traders will buy $1 worth of bank money for just 54 cents in genuine cash, according to recent reports.
Comparing the price of bitcoin in Zimbabwe against its international price also gives some clues into how far the new currency has tumbled. Last week bitcoin traded at $13,185 on the Golix, a Zimbabwean bitcoin exchange, but only $7190 on U.S. exchanges. We need to take the price of $13,185 with a grain of salt, because Golix is a very illiquid exchange. In any case, the ratio between the two bitcoin prices implies that a Zimbabwean bank dollar is only worth 54 cents in genuine U.S. dollars ($13185/7190), confirming the unofficial street price in the previous paragraph. Put differently, in just one year Zimbabwe's new currency has lost almost half its value.
Economist Steve Hanke, who helps maintain the Hanke-Krus World Inflation Table, has used interlisted stocks on the Harare and London stock exchanges to infer that Zimbabwe’s inflation rate has soared to 77%. (I described this technique in more detail here). When inflation exceeds 50% per month and lasts for at least thirty consecutive days it qualifies as hyperinflation, which means that Zimbabwe’s current currency collapse will be added to the Hanke-Krus table.
Given that Mugabe and his cronies have already shown a penchant for destroying currencies, as long as they are in power it seems unlikely that the current inflation will stop. As I was writing this post, however, the situation in Zimbabwe has dramatically changed. On November 14, the army announced that it had placed Mugabe under house arrest. We don’t know if he will be permanently removed from power or if the situation is just a temporary one. If a new government can be established, and the international community mobilized to support it, it is possible that the collapse in the new currency will be halted, perhaps even reversing back to par. For instance, a large enough IMF loan might allow the RBZ to uphold its original promise to convert bond notes and deposits into genuine dollars on a 1:1 basis.
The market may already be pricing in an improvement in the odds of the Zimbabwean currency being stabilized. Over the two days the Zimbabwe Industrial Index has plunged by over 100 points or 20%, as the chart at top illustrates. This correction may be partly due to operating uncertainties faced by listed firms given the lack of visibility surrounding future leadership. But the largest chunk of the decline is surely a pure monetary phenomenon. Since all stock prices are quoted in Zimbabwean money, a massive increase in the purchasing power of money will cause stock prices to fall.
Many outside the country have no doubt been anxiously watching Zimbabwe's monetary experiment, especially in Europe. In the same way that Zimbabwe was part of the U.S. dollar-zone, most European nations are part of the Eurozone, in some cases reluctantly so. Zimbabwe offers these nations a blueprint for quickly exiting the monetary union. That may be one reason why the President of the European Central Bank, Mario Draghi, was so quick to shoot down Estonia's recently mooted state-backed cryptocurrency, the Estcoin. By nipping it off at the bud, he ensured he wouldn't have a home-grown bond note problem.
This blog post is the first in a series of guest posts on BullionStar's Blog by the renowned blogger JP Koning who will be writing about monetary economics, central banking and gold .
India’s Government Makes Banknotes Worthless by Decree Overnight
As I write this in the morning of 9th November 2016, there are huge lines forming outside gold shops in India — and gold traded heavily until late into the night yesterday. Depending on who you ask, the retail price of gold has gone up between 15% and 20% within the last 10 hours.
At some places, it was sold for as much as US$ 2,294 per ounce. That is, if you can actually find physical gold — gold inventories at stores are rapidly depleting. All of this happened well before the international price started to move up because of the election results coming out of the US.
Last night (8th November 2016), India’s government banned the use of Rs 500 (~$7.50) and Rs 1,000 ($15) banknotes. This pretty much made most currency-in-use illegal. Banks and ATMs are closed today. The government believes that doing this will help eradicate corruption and push counterfeit money out of circulation. According to the Indian government, the counterfeit money tends to come from Pakistan and helps finance terrorism.
My first instinct when I heard the news was that people would be on the streets this morning. There would be riots and the Indian Prime Minister, Narendra Modi, would be unceremoniously thrown out. Despite being a huge critic of him, I thought he at least had the spine to take bold action, however erroneous it might have been.
I am sometimes too optimistic about India and expect too much goodness from Indians. And I was wrong.
In the morning no opposition against the government was in sight. But there was some animosity detectable between people. Forgetful that they had lined up until late into the night yesterday trying to get cash out of ATMs before midnight, had fought at gas-stations to get their gas tanks filled, and had suddenly been trapped with unusable currency, people exchanged congratulations on what Modi had done.
What Modi had done — contrary to what I initially thought — wasn’t a bold move. It was a populist move, designed to please the 98% who do not save. While they are really driven by envy, these 98% are putting on a brave face, celebrating the alleged defeat of corruption. To them the fights of yesterday — at gas stations and elsewhere — and the loss of trust in their fellow citizens is merely collateral damage.
Fresh Avenues for Corruption Immediately Open Up
Those who find themselves stuck with high denomination bills today, must accept as little as Rs 700 in usable currency for every Rs 1000 of banned currency.
At least theoretically, people can still use the otherwise banned bills at hospitals, gas stations, pharmaceutical shops, and train stations. As one would expect in India, these places have been converted into corrupt currency-exchange shops as of today. Some well-connected people are prepaying for their medical treatment.
But for most legitimate uses, none of these organizations are accepting the otherwise banned instruments. Why should they, when they can force customers to pay in the still-legal currency and then buy the banned instruments for Rs 700 for every Rs 1000 in face value, making a neat 43% extra profit without doing anything?
In India, a country not driven by morals or reason, almost everyone will exploit an opportunity to make an extra buck, however unethical it might be. Those who look deeper, understand that corruption in public life comes from ingrained corruption in India’s society and culture. If one had to make an effort to remove corruption this is where one should start.
1,000 rupee banknotes – worth 700 rupees each today, available from the newest entrants into the money-changer business. Unfortunately, their business model is fraudulent; it sure seems a strange way to “fight corruption”. Photo credit: Reuters
Today, there is utter chaos in the market, with only the spontaneously erupted black market available to bypass the ban — most people simply don’t have anything else but the banned currency bills. Some are booking train tickets for future rides and are subsequently canceling them — they can use the banned currency to buy the tickets and can then get legal currency back after ticket-cancellation charges. This is costing people a lot of time, but it is the only way they can stay afloat and buy food. Others are taking different measures, equally desperate.
By any sane person’s reckoning, corruption has skyrocketed for the moment. So has gold. Those who run businesses have lost whatever remnant of trust in the government they still had. In recent months several businessmen have confessed to me that they are closing down, because the state has become increasingly heavy-handed and bureaucratic. Contrary to what the World Bank and IMF are saying, India is suffering economically. Its institutions are crumbling. And India is on the path to becoming another banana republic.
Within a few days, assuming this issue is handled appropriately — which it won’t be — most people with a certain amount of banned currency will be able to deposit it at banks, although tied to withdrawal limits. The banking system will stay partly frozen. After the banks open tomorrow, I expect to see riot-like scenes outside bank branch offices for a few weeks.
Huge chaos in the Indian economy should be expected to continue — as India’s government is simply incapable of bringing liquidity back any time soon. Businessmen will waste their time dealing with this nonsensical event, instead of investing and creating wealth. India simply continues to do more and more of what makes it an uneconomical and wasteful place to invest in.
Will the Plan Succeed in Reducing Corruption?
But will this eventually lead to a reduction in corruption? Let us use the gold market as an example to understand how the Indian economy operates. Any import of gold is subject to a cumulative tax of about 11%. The retail price of gold should be around 111% of the international price. Ironically, it mostly sells for 105% of the international price. Putting it simply, any law-abiding businessman must lose this 6% differential, ensuring his bankruptcy.
In reality most of the gold entering India is brought in by smugglers. These smugglers are happy to pass on almost half of their profit to consumers, while at the same time paying bribes to the Indian army, customs officials, other bureaucrats and politicians. If one wants to run a gold business, one must use smuggled gold if one wants to be competitive.
Virtually all businesses in India have to be run this way. Without paying bribes, no business has a hope of succeeding in India. Corruption is in the blood of India and is not easy to get rid of, even if by sheer luck India finds good political leaders one day.
Corruption is so omnipresent in India that you don’t really have to look for it. It is always there. What Modi is doing is merely political theater to fool the gullible. His decision to ban cash currency is actually proof that he has utterly failed to achieve any meaningful change in India.
I have yet to meet a public servant in India who does not ask for a bribe. During Modi’s reign, not only corruption has gone up, the state has become extremely heavy-handed. As what is happening today shows that the government’s anti-corruption measures themselves are ironically leading to a huge increase in corruption.
Unsuccessful Google search in India… - Cartoon by Thommy
Conclusion - Part 1
Unfortunately, India’s degradation will not stop. Indians have become extremely nationalistic over the last two decades. They are now very easy to herd around. Under the color of nationalism they can be made to accept anything – of course, only as long as the victim is someone else. The currency issue of today affects maybe 2% of the entrepreneurial population of India, so the remaining 98% can claim higher moral ground for themselves. The reality is that without these 2%, India could rapidly become a carbon copy of Idi Amin’s Uganda.
What India needs is not a focus on the removal of corruption, but the removal of regulations and restrictions on wealth-creation. For now the state is doing exactly the opposite, as it has in the past. Most importantly, this poison of totalitarianism comes from the extremely irrational society of India - in which corruption is entrenched.
Part 1 above covered what happened in the first two days after India’s government made Rs 500 (~$7.50) and Rs 1,000 (~$15) banknotes illegal. They can now only be converted to Rs 100 (~$1.50) or lower denomination notes, at bank branches or post offices. Banks were closed the first day after the decision.
What follows is the crux of what has happened over the subsequent four days.
Today India is on the verge of a major social-political crisis, unless either the government backs off from the decision of banning the currency or some real magic happens. There is chaos in the streets and daily life is slowly but surely coming to a full halt.
What Modi did was not only heavy-handed, hugely arrogant, and of no value, it has been very badly implemented to boot — as everything in India always is — and carries the real potential of escalating and snowballing into something horrific. They could have seen that this was not going to end well by simply using primary school math.
Modi, Nationalism, and the Public School-Indoctrinated Middle Class
India today is like a cult under the influence of Narendra Modi — in which unlike in the past, not the poorest or uneducated citizens, but mostly members of the so-called educated middle class participate. Over the last two decades, people have been exposed to mass education, TV and nationalistic propaganda without being taught an iota of critical thinking skills.
In a society in which the concept of reason does not exist, this has made these people receptive to any kind of propaganda with a nationalistic or Hindutva bent. (Hindutva = fanatical Hinduism, which is rapidly metastasizing).
To aggrandize his position, Modi ordered a lot of military-hardware that India cannot afford, escalated tensions with Pakistan, and conducted what was very likely a fake surgical strike inside Pakistan. This united Indians under the flag.
Now, the demonetization of the Rs 500 and Rs 1000 banknotes was tagged with nationalism, anti-corruption, and anti-terrorism. Simple-minded, slogan-susceptible persons were hardwired to accept an erroneous causality. Those who did not go along were made to be afraid of being called pro-terrorist elements.
Those in the middle class have taken what they deem to be the higher moral ground, for they have mostly avoided suffering from the demonetization. Lacking moral instincts — which is unfortunately the case with much of Indian society, given its deep-rooted irrationality and superstitions — they cannot see or feel the pain of those who are suffering, even if that suffering stares into their faces.
But events are in motion that will likely very soon lead to these salaried members of the middle class starting to feel the pain as well. Their instinctive trust in Modi is likely within weeks of coming crashing down, not because of reasoned argument, but because they will be facing similar problems as the ones the common man is now facing.
Conversion to the New Currency
I went to convert my banned banknotes into new ones. The largest amount one can have converted is Rs 4,000 ($60), until further notice. There was a huge rush of people at the bank. Arguments were erupting, as people refused to stand in queues and the banks gave no explanation of what needed to be done. Fights were breaking out.
Amid the chaos I finally learned that there were three queues I had to go through in a sequence. I had to get a form from one counter, which I had to fill in with my name and address, my ID card details, the serial numbers of all the bills I wanted to exchange, and my cell-phone number.
At the second counter, I then had to present the completed form along with a photocopy of my ID card. I had to sign on the photocopy which an official then stamped. With my banknotes, the form and the photocopy of my ID card, I then went to the next queue to get my currency converted at a third counter. The whole process took about two hours. For most people in the busier parts of the cities, it took much longer.
Day 1 of the banks opening. Poor, desperate people, whom the government treats like slaves or perhaps insects. Somehow these people have been brainwashed into thinking they live in a free country. My granddad kept photographs of British royalty on the walls of his office until his final days, for he had realized that the British had treated him much better.
Anyone who thinks that a country which wastes two hours of every citizen’s life to convert his own $60 can ever hope to be an economic power is drinking too much Kool-Aid and cannot do primary level math. Forget any possibility of removing unaccounted for money or reducing corruption, what Modi is doing is a recipe for the destruction of whatever legitimate economy there is.
That same afternoon, I went to the post office with a friend who wanted to get his money converted. After waiting a long time there, we found out that the post office had run out of cash. Since then most ATMs have had limited amounts of cash available and banks keep running out of cash as well.
The queues have continued to grow. People start lining up late into the night waiting for banks to open and still have to go back home with no cash. What started with two hours of queuing is becoming an endless slog now.
An endless queue to convert Rs 4,000 (USD 60). Will they actually go home with their new cash?
The Problems Go Much Deeper
Half of India’s citizens do not have a bank account and around 25% do not even have an ID card. These are the country’s poorest people, who have no way of converting their money – even if they learn how to do it, which is already a nigh insurmountable hurdle. Also, those who are old, disabled or sick have no choice but to suffer, for without personally visiting a bank branch office, one cannot convert one’s banknotes.
97% of the Indian economy is cash-based. With 88% of all outstanding currency no longer usable, the economy is coming to a standstill. The daily-wage laborer, who leads a hand-to-mouth existence in a country with GDP per capita of a mere $1,600, no longer has work, as his employer has no cash to pay his wages. His life is in utter chaos. He is not as smart as Modi - despite the fact that Modi has no real life experience except as a bully and perhaps in his early days as a tea-seller at a train-station. He has no clue where his life is headed from here.
These people are going hungry, and some have begun to raid food shops. People are dying for lack of treatment at hospitals. Old people are dying in the endless queues. Some are killing themselves, as they are unable to comprehend the situation and simply don’t know what to do. There are now hundreds of such stories in the media.
Small businesses are in shambles, and many will probably never recover. The Hindu wedding season has just started and people are left with unusable banknotes. Their personal and family lives are now an utter disaster.
Desperate people raiding a supermarket
Lacking moral and rational anchors, and hence compassion, members of the salaried middle class are unperturbed. Their salaries get taxed and most of the bribes they are getting end up in gold or property investments. In their minds, poor people and small businesses don’t matter. In the hypocritical culture of India, as long as the middle class is not suffering - for the time being — they prefer to take what they believe to be the higher moral ground.
Why This Problem Will Get Much Worse
Let us do a few simple numbers… What has been made illegal comprises 88% of the monetary value of all currency notes in circulation. In an economy based primarily on cash, the liquidity of cash is the lifeline of the economy. This requires that 88% of the new currency be rapidly dispersed into the market.
The Indian government has absolutely no history of being able to entertain a project of this type or magnitude ever and after the British left, India’s institutions have continued to deteriorate, so hope is not an option. If they fail to issue enough new bills, the very limited supply of Rs 100 notes will disappear within a few days.
As any rational person has a tendency to store good money while using bad money in transactions, people will hide all newly released currency as well as Rs 100 banknotes until full liquidity is restored. The rich and the well-connected have already done what was needed.
A reminder of Gresham’s law for Modi: “Bad money drives out good money.”
Those who have no need to convert their money as all their cash is already in the banking system (as is the case with the salaried middle class), which they think is making them look like a heroes in the eyes of Modi and is giving them a sense of moral superiority – they are nothing but turkeys being groomed.
Banks are giving out a mere Rs 20,000 ($300) a week at best. Their lives will suffer and for all intents and purposes, their accounts are frozen. This is Cyprus ten times over – they just haven’t realized it yet.
Whichever way one looks at the above numbers, India’s economy is going to start suffocating, within weeks, if not within days. And a serious political and social crisis will take place, which will eventually acquire a life of its own. That is when the as of yet unperturbed salaried middle class wakes up with pain.
As in any irrational system, it is not reason and morality that will have convinced them to scuttle their hypocrisy and limited vision, but the violence and pain that they themselves will suffer.
Politicians and bureaucrats of course cannot be seen queuing at the banks. Many bank branches apparently had their cash secretly replaced by the now-illegal bills before the first day of reopening. While no more than two bills of Rs 2000 each should have been collected, those better connected apparently haven’t had a problem with this and have been shown showing off packets of the new currency they have. All this cash will do nothing but end up under mattresses, as it has in the past.
As I walk around, corruption is everywhere and has grown exponentially, not only in financial terms but worst of all, in terms of the humiliation and degradation Indians are suffering. And I don’t know how a humiliated, soulless person can be anything but corrupt.
In village after village people have stopped working, even if they had work, as they can now join the queues at the banks to convert other people’s banknotes for a commission. For many young people, this is a wise entrepreneurial decision, as they are making many times the money they would have otherwise made for now.
But they are being trained to make money from non-productive activities — not from wealth-creation, but from unnecessary problems created by the government. Are they being groomed for a corruption-free society? One has to be naive to respond affirmatively.
Fear of the tax authorities means that the level of bribes being offered has gone up. Random people can now impersonate tax officers and collect bribes. People are in the grip of a fear psychosis. Many are emptying their bank deposit boxes, which means that crime will inevitably increase in coming days.
People are constantly worrying about what Modi’s next knee-jerk act might be and how to protect themselves against it. A police state is knocking at the doors.
A receptive environment has been created in which all kinds of rumors are taking wing. Today, salt is selling for Rs 400 ($6) per kilogram, as rumors have been making the rounds that it is about to disappear. This of course creates a situation in which it will actually disappear. The same is happening with sugar. The largely irrational masses are eagerly devouring a great many random rumors.
Lesson for Modi: Never, ever destabilize a society that works through conventions rather than reason, for it has no way to return to a normal state of affairs without a huge amount of pain and violence. Simply look at neighboring countries in order to understand this.
Chronic fear is slowly overtaking the mood of Indians, particularly those who run businesses. They have not only completely lost their trust in the government, but the tax department has been raiding people’s premises to scare those who are trying to salvage what they have.
They have stopped worrying about creating value. Everyone is talking about what to do with the banned banknotes, for even if they are fully accounted for, people fear that the increasingly rapacious tax authorities will make trouble anyway.
Uncertainty has gripped the populace. Not everyone is capable of grasping the situation and dealing with it.
People are now converting whatever they can into gold, silver, and mostly for the first time into the US dollar and other foreign currencies as well, all of which are trading at huge premiums. Money is also moving out of the country. Gold has shot up to as much as $2,800 per ounce, if you can find it.
Lesson for Modi: The reason people trust Switzerland is because it has hundreds of years of history of protecting private property. Singapore has done an equally good job, but it still lags behind Switzerland, because trust requires a very, very long history of institutional honesty and integrity. India is back to level zero for now. When future generations look back, they will see the current demonetization as the worst event in the history of post-colonial India.
Finally, the new bills have actually worsened the counterfeiting problem they were supposed to solve. People do not have any experience with what the new banknotes look like. Within a mere three days, counterfeits are already in circulation. Contrary to the government’s claims, the new bills are not any more sophisticated than the old ones and are made of simple paper.
Why Has the Government Miscalculated?
The most productive job Modi ever had was running a tea-shop at a railway station, which he then gave up to become a bully. He is a complete stranger to complex thought. He is simplistic in his thinking and does not understand the second-order consequences of his actions.
First he increased Hindu fanaticism, then he participated in collectivizing people using nationalism, then he created problems with Kashmir through his heavy-handedness.
A simplistic mind is also arrogant. Such a mind — unable to conceive the possibility of unintended consequences — thinks all that has to be done is to issue orders and everything will fall in place. Alas, this may work when shooting innocent people in Kashmir and in other destructive ventures, but when it comes to institutionalizing social progress, a more complex and intelligent approach is needed.
All of India’s institutions have continued to deteriorate since the British have left. They are rotting away and are in shambles. India had some breathing space over the past three decades because of the free gifts of the internet and cheap telephony which it got from the West.
This has merely made Indian governments more rapacious and so-called educated Indians more arrogant. They collectively lack the capacity to improve India’s institutions after having destroyed them. Demonetization may well be the straw that will break the camel’s back by accelerating the deterioration of India’s institutions toward the point of breakdown, perhaps in weeks if not already in coming days.
Conclusion – What Can One Do?
As Indian, be a speculator – even if the government does not like it and will blame you for all ills. Try to keep as much of your money in cash, in Rs 100 notes. Rs 2,000 notes have no value when you go shopping for groceries. Keep a supply of water and dried food sufficient for a few months’ needs.
Cash is disappearing and even before that the economy was stumbling. It might take just one more small domino — more strain on liquidity — to bring about systemic problems in the economy that could bring crucial transactions, businesses and supply lines to a halt.
If systemic violence spreads, everything will be complicated further. Think of Zimbabwe. It pays to be prepared, particularly when we are ruled by zombies.
Image captions by PT. Photos and videos by courtesy of Jayant Bhandari.
Jayant Bhandari grew up in India. He advises institutional investors on investing in the junior mining industry. He writes on political, economic and cultural issues for several publications. He is a contributing editor of the Liberty magazine. He runs a yearly seminar in Vancouver titled Capitalism & Morality.
How about a mansion in every country, an airplane at every airport and a private island in every ocean?
How about 3 eggs?
When Zimbabwe issued its infamous 100 000 000 000 000 dollar bill, it could buy 3 eggs on the day it was issued. A few days later, it could only buy one egg.
Unbacked fiat/paper/credit, and nowadays electronic currency, has a poor track record. After studying this list of 609 defunct currencies, out of which 153 died due to hyperinflation, it's obvious that every time fiat currencies are tried, they die through hyperinflation, war or political decrees.
Using the debt-based US Dollar as a store of value creates massive imbalances and misallocations globally. With an unprecedented debt bubble fuelling paper markets such as stocks and bonds, we stand on the cliff edge of a vertical drop.
Since the Nixon era, we have suffered under a fiat currency ponzi scheme wiping out most of the purchasing power of our currencies.
In MLM schemes, the idea is to recruit naive participants downstream to generate compensation for the recruiter.
This is exactly how the US Dollar and other fiat currencies work.
Early receivers of the MLM scheme such as the government, the banks and the central bank gain purchasing power whereas late receivers, such as us normal people, lose purchasing power.
Fiat paper currency is nothing but a cleverly designed MLM scheme to slowly over time steal and redistribute your private wealth.
Defend Your Assets
With the massive redistribution of wealth taking place through taxation and inflation, you have to defend your assets. Key self-defensive tactics include:
- Protect yourself by keeping your assets out of reach for the government and banks
- Minimize counter-party risks
- Ensure you are protected against currency collapses and bank runs
- Hold your assets in such a way that there's no reporting required to government
- Protect yourself against exchange and capital controls
Crooks can't help steal whether it's directly in broad daylight through a bail-in like in Cyprus in 2013, through taxation, through inflation or through confiscation such as the gold confiscation in the 1930's when the US president Roosevelt took the United States off the gold standard and confiscated private gold holdings.
How can you protect yourself? Gold is the natural answer as it resists inflation, maintains purchasing power and can be held confidentially.
Buying gold isn't enough though. What if your gold purchase is within reach of the government? If you buy gold in your home country, a tax agency such as the IRS in the United States can easily audit the bullion dealer to find out about your purchases. In addition, there's also reporting requirements for certain bullion transactions.
When it comes to bullion storage, diversification is key. It's certainly wise to keep some of your bullion in your own possession but don't put all your gold eggs in one basket.
Offshore Bullion Storage
With the financial repression we are witnessing in the West expressing itself through taxation, inflation, bail-ins and confiscations, it's important to store some of your bullion offshore in a safe jurisdiction favoring confidentiality and security.
Gold has traditionally been stored in financial hubs such as in London, New York and Zurich. With doubts whether there is any gold left in the London and New York vaults which isn't already encumbered, Singapore is emerging as the strongest alternative for offshore bullion storage. Singapore clearly distinguishes itself as the best jurisdiction in the world to buy and store gold:
Singapore has no taxes on bullion
Singapore has no reporting requirements when you buy/sell/store bullion
Singapore has a stable pro-gold government creating a gold trading hub
Singapore has a strong rule of law and is one of the safest countries in the world
Singapore is a centre for wealth and asset preservation
Singapore consistently ranks top 3 in the world for business friendliness
Singapore strongly protects property ownership rights
Although we don't recommend holding wealth with banks, other than what you need for short-term expenses, Singapore is host to some of the best capitalized banks in the world such as DBS, UOB and OCBC.
With banks and international institutions pushing for a cashless society so as to be able to impose negative interest rates, surveil your transactions, and impose restrictions on your wealth, Singapore continues to be a cash-friendly jurisdiction. Although Singapore in 2014 stopped printing the world's most valuable banknote, the SGD 10000 dollar note, it's possible to use cash for all purchases including purchasing bullion. The SGD 10000 dollar note will continue to be valid indefinitely and the SGD 1000 note is still one of the most valuable worldwide.