Indian Gold – A Lesson in Counterparty Risk

Listeners to our weekly wrap podcast will know that India’s central bank recently launched its desperate bid to ‘monetise’ the enormous amounts of gold sitting in what used to be, prior to China’s last few years, the world’s largest consumer of gold.  Gold is India’s second biggest import after oil, so the higher the imports the more damage to their trade deficit and pressure on their currency and they are long term holders of gold so it’s not circulating in the economy either.  After efforts to curtail imports through extraordinary import charges and restrictions (with increasingly limited effect), this latest cunning plan would see the government pay owners of physical gold a return for them lodging it in their trusty hands in return for a paper bond.  The idea is the government can then ‘lend’ the gold to jewellers and auction it to bolster foreign reserves cash holdings.  This is gold rehypothecation by any other name.  We often talk of the ‘strong hands’ of the East and the ‘weak hands’ of the West (most recently here).  It should be of no surprise that the strong hands of India are not falling for this trick and in its first week a laughable 30kg has been processed.

One of the fundamental virtues of owning physical gold is it has no counterparty risk.  EVERY other financial asset (including cash) is built upon unprecedented debt.  The canny Indian’s, indeed the East as a whole, know through 1000’s of years of history that there is only one ‘money’ when this debt based house of cards comes crashing down.  They are not about to introduce counterparty risk to that proposition.