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More hand-wringing about euro''s rise, and some speculation about intervention
By Sala Kannan
www.DailyReckoning.com
Tuesday, November 16, 2004
It was July 1, 1991, the day of my cousin's wedding.
"You have to wear more gold, Sala. It's auspicious," my
mother said, as I was getting ready.
As a teenager growing up in India, I hated wearing
traditional gold jewelry. It was not fashionable enough.
Only old people wore gold jewelry. I was determined
not to wear all that gold to the wedding. I would create
all the drama I could to avoid it.
On the same day, a different kind of drama was unfolding
in Bombay, India's financial nucleus. Ironically, it would
involve gold too.
On July 1, 1991, the Reserve Bank of India was in chaos.
Foreign exchange reserves neared zero and the country's
debt was spiraling out of control.
July 1, 1991, was the day India went bankrupt. It was the
day the emerging Asian superpower's external debt reached
a record $69 billion -- a third of its GDP. Thanks to the
Gulf War and soaring petroleum prices, India's imports
were so exorbitant that the country could not pay for them.
How was it going to service its mounting debt? With no
foreign reserves and weak export income, how was the
Reserve Bank going to pay for India's costly imports?
Those were daunting questions that weighed on the minds
of economists, investors, and individuals alike.
What weighed on my mind that day was just one thing:
How could my mother force me to wear ugly, ancient
gold jewelry? What will my friends think of me?
"It is so uncomfortable," I tried to protest.
"So what? Twenty years from now it will be worth so
much more, and you will be glad you have it. Besides,
everyone at your cousin's wedding will be seeing
how much jewelry you're wearing, so you better put
on a couple more bangles."
It seemed like I had no defense. I panicked.
The Reserve Bank officials panicked too; they could
turn nowhere for financial aid. They were blacklisted by
Standard & Poor's, Moody's and other credit rating
agencies. Investor confidence in India was at an all-time
low. No international bank, no country, no institution,
no individual was willing to put a penny into the country.
And why should they?
The Indian rupee was worth nothing. In 1991 one rupee
fetched 0.002 U.S. dollars. The rupee was a mere fraction
of a cent.
To make things worse, there was political turmoil. The
government was unstable. Rajiv Gandhi, a former prime
minister, had just been assassinated. India's financial
house was incapacitated. There was no way out of this
vicious cycle of debt.
No way out, except borrowing against the country's most
important asset -- gold.
Back home my mother's will to have me wear gold had
prevailed. On the way to the wedding she said, "Someday
I hope you will appreciate that we bought you gold."
Embarrassed as I was, I went to my cousin's wedding
dressed in traditional gold -- just like everyone else
there.
On July 1, 1991, when India was facing sure bankruptcy,
the Reserve Bank had to pull an embarrassing move that
saved the entire country from certain doom and gloom.
Then-Finance Minister Manmohan Singh pulled the
trigger and sold about $200 million worth of confiscated
smuggled gold. (There was a thriving black market in
gold to meet growing demand.)
The Reserve Bank shipped more of its reserves to the
Bank of England as collateral and obtained a $400
million loan to correct its balance of payments and
finance its debts. In other words, pledging the Reserve
Bank's gold was the only savior. It was also a huge
embarrassment: A country that worshipped gold as an
auspicious item now had to ship it away to save itself.
The RBI used gold to save the country from spiraling
debt. It used its gold to keep the banks open and in
business. It used its gold to keep the economy running.
And since 1991 India has gone on to receive an
investment-grade rating by Moody's, and the Indian
stock market is up nearly 400 percent. India now has a
healthy trade surplus of $31 billion and owes the
International Monetary Fund absolutely no money.
Gold is hugely important in India -- both as an economic
safety net that saved it from falling deeply in debt in 1991
and as a personal store of real wealth.
This tradition of gold has ancient roots. In 16th-century
India, people stored their wealth in the form of gold and
other precious metals in order to keep it hidden from the
tax man. Even today Indians hoard gold and worship it.
India's goddess of wealth is portrayed with gold coins
falling from her palms to symbolize prosperity. She is
sometimes even referred to as Swarnalakshmi, or the
Goddess of Gold. Gold is considered so auspicious
that no wedding is conducted without the exchange
of large quantities of gold.
Weddings aside, Indians hoard gold no matter what
the economic climate. They venerate the Goddess of
Gold. And in today's easy-money economy, they
continue to amass gold -- not only because it is
auspicious, but also as a consequence of two
specific economic environments.
First, the Indian stock market is relatively unsophisticated.
The total market cap of the Bombay Stock Exchange Index
as of April 2004 was $226 billion. On the other hand, the
Dow Jones Total Market Index for the United States had
a market cap of about $12 trillion. Trading volumes are
comparatively low, derivative trading is a relatively new
concept, and the Indian stock market is not very accessible
to the common man. Investment vehicles are few and
available only to the wealthy. So most families simply hold
gold.
Second, for those in remote villages with no banks or
safe-deposit boxes, storing cash at home can be
dangerous. Instead they invest in gold jewelry and wear
it on their persons. Even the poor own at least a small
amount of gold.
As a result it is estimated that Indian families own
between 9,000 and 15,000 tons of gold. At today's
dollar value, that is about $115-192 billion worth of
gold -- approximately 10 percent of the world's supply!
That is a huge safety net.
This country owns nearly $200 billion worth of an
asset that is appreciating in value and has just embarked
on a phenomenal bull run.
Gold can be sold or pledged in times of financial need.
In some circumstances it is the most liquid asset a family
owns. It may be easier to liquidate one's gold than to get
a bank loan. Unlike many popular financial assets, gold
is not debt-backed. Gold is no one else's liability.
So India's vast gold reserve is insurance against financial
failure.
Will this emerging superpower see the crisis of 1991
repeat itself? It is highly unlikely. After all, the man
who was finance minister in 1991 and opened up the
Indian economy to global trade is now the country's
prime minister. India has regained its investors'
confidence and is a destination for foreign investment.
But should they ever face a financial crisis, the people
of India have a colossal hoard of gold to fall back upon.
The Goddess of Gold is smiling upon them.
P.S. My sister called last weekend. "You won't believe
what Mom made me wear to yesterday's party," she
complained. I think I can make a very good guess.
Some things will never change -- and that just
reinforces my faith in gold.
---
Born in India and a graduate of the University of
Cambridge, Sala Kannan boasts connections with
economists and industry insiders worldwide. An
expert on global economic trends, she's especially
well-versed in developing nations such as India,
Brazil, Argentina, and China.
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