Anger in India is growing over the recent and sudden demonetization of certain types of cash. The Indian government just made 500 and 1,000 paper rupee notes (worth a mere $7 and $15 respectively!) illegal, allegedly to cut back on counterfeiting and crime. Supposedly, they will be replaced by newer and more counterfeit-proof paper money. The cash ban will be very good for gold demand but is no way to run a country.
All countries periodically upgrade their paper currencies. The Indian government, however, acted differently than more responsible nations. When the US introduced new $100, $50, $20 and $10 bills, for example, it did so in a slow and controlled manner. There were no time limits on exchange. Older notes retained their value indefinitely. Eventually, in the ordinary course of business, these old notes make their way into the banking system (and still are making their way there), where they are sent back to the US Treasury for destruction and replacement. The same process takes place periodically in a host of different nations.
The Indian government, in contrast, has put a time limit on the legal tender nature of older notes. It gave Indians a few days notice of its decision to phase out old versions of the 500 and 1,000 rupee notes. It was done, ostensibly, to foil criminals and currency counterfeiters. Yet legions of innocent old grandmothers and rural dwellers, who are known to keep such notes as mattress-based savings, were given only days to spend them! A few days later (now) they face the loss of their savings, or possible confiscation if they arrive at a bank with a lot of saved rupees and not enough documentation. Many of these people don’t even have a bank account. They are unable to exchange them directly, and will have to rely on third parties to do so, incurring fees in the process just to access their money.
This is an incredible and outrageously capricious action. Yet, the Indian government defends it and Prime Minister Modi has told angry Indians to give him until December 30th to “clean up” the country. Mostly, I think, he means that long time tax cheats will lose the value of their cash. Obviously, most people like it when corrupt people are punished. Most Indians would like to see their nation cleaned of corruption. Most want everyone to pay their fair share. No honest person could disagree with that idea.
PM Modi’s intentions seem to be good, but the way in which he is going about it is all wrong. The ends do not justify the means. In this case, he is permanently damaging the very system he claims to defend and support. The proper way to deal with people not paying their fair share of taxes is to gently lure them into opening up bank accounts. To do that, you first expand the banking system into all parts of the country. You encourage the use of savings, checking and time deposit account and credit cards instead of cash, and begin auditing all questionable tax returns or those who don’t file returns at all. But, gently nudging people into compliance takes years, and Modi’s government wants money now.
In its impatience, the Indian government will succeed in imploding the population’s faith in the Indian rupee. Historically, this type of capricious behavior is the very thing that causes people to lose faith in their government. A lot of Indians keep their savings in the form of gold, rather than in banks or even in cash, because they don’t have faith in the rupee. This demonitisation scheme has validated that lack of faith. Those who kept their money in the form of cash are now hurting. Those who kept it in the form of gold and silver coins are sitting pretty.
In a country that loves gold, in the first place, PM Modi has just lit a new fire under long term demand for the pretty yellow metal. Reports are that demand is now skyrocketing in the immediate aftermath. The sudden spurt will level off in time, but it is merely a beginning. In the long term, the Indian currency is now delegitimized. The general population of India has lost whatever little faith it ever had in the rupee. A higher percentage of people’s wealth will, henceforth, be stored in gold or silver than ever before. It will do no good for the Indian government to continue or increase the persecution of importers. The precious metals demand will be met by smuggling.
In the short run, sharp upturns in demand for gold will have little effect on world prices. That’s because politics, leveraged trading, and the desire of central banks to silence the “canary in the coal mine” are more important factors. These can overcome real demand for a long time. Increases in demand can be met for as long as foolish policy-makers in America are willing to piss away the nation’s gold reserves. They’ve done, I believe, for a very long time, in a foolish attempt to hold down prices. The US gold reserve, however, is not sufficient to hold down prices forever. That is especially true now, when the incoming President is almost certain to stop its continued utilization as soon as he takes office on January 20th.
That is, perhaps, why market manipulators are targeting stop loss orders, right now, and seeking to squeeze long gold buyers in a number of ways. They are simultaneously pushing up the US dollar’s exchange value in a flurry of fierce activity that is not supported by any change. Induction of market panic and a short squeeze in the dollar, simultaneous with a long squeeze in gold, however, will help them escape from positions that will soon become very unprofitable in both, before the change in administrations.
With production continuing to fall, and demand continuing to rise, this new factor, which will cause a probable further rise in Indian demand, is just one more thing that will affect prices in the next few years. I’ve covered many of the factors already in various postings on this blog, and in a myriad of articles I’ve written for Seeking Alpha. In all likelihood, in my opinion, gold will be selling in the $5-10,000 ounce range by 2020, depending on surrounding factors at the time.
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