The specific subject of State Bank of India and what has happened from the clumsy attempt by Modi to eliminate the payment method of using cash will almost certainly backfire on them.
By the fourth quarter of 2016, the Prime Minister of India Narendra Modi demonetized approximately 86% of the rupees that were in circulation and offered to convert them into small currency notes or into a bank account until 31 December. After that, the notes will not have any redemption value.
With Narendra Modi - State Bank of India action is only going to make Indians less proactive dealing with the government or its money. Since the new Gandhi notes went into circulation, they are overwhelmingly rejected by an understandably suspicious public as the preferred form of money.
That means that the purchasing power of the rupee will diminish more quickly that it would have had State Bank of India not disrupted what had turned into a fairly stable money situation.
When it comes to their actions, regular people are far ahead of financial analysts from the West. They anticipated this outcome rather quickly for themselves. Despite the government's longstanding attempts to convince them to do otherwise, people have rushed to get their worthless rupees converted into another form of money that the State Bank of India has no control over, and that has been trusted for millennia, and that is gold.
People know that when priced in rupees, gold will be much more expensive several months down the road, so anything that they can cash in will not be cashed in for rupees but for gold instead.
That is why gold in India is currently trading at quite a substantial premium compared to international prices. The supply of gold is restricted by the Indian government due to always correctly viewing gold as a competitor to its fiat money.
Central planners accordingly condemn gold and claim it was more appropriate in the past than it is in our current economic environment. They view gold imports as being a form of unproductive hoarding since they dismiss its relevance as a superior form of value and relevance as money.
The State Bank of India and government also seem to make the mistake of thinking that if they eliminated gold imports, that there would be an improvement to the balance of trade. Since the era of Gandhi, this has resulted in various regulations and acts. However, this has only served to encourage gold smuggling.
Importing gold has never ceased, and over the long-term, there has been increased response to every new change in money policy, and following the clumsy action by the government will continue.
Government and State Bank of India ineptness is having a considerable impact on the gold market. Earlier this year, gold demand had actually declined at its officially recorded level, following a period of fairly stable currency.
The new sales tax was higher than the premium on gold, which put a lot of jewelers out of business, due to the fact that they couldn't compete against smuggled gold since it was not taxed and the premium it attracted was lower than the sales tax.
This latest action will most likely put more jewelers out of business. Consequently smuggling will continue to increase, especially if the purchasing power of the rupee declines due to increasing public distrust in its money.
The central banking community, which is led by the Bank for International Settlement, had concerns that Indian gold demand was increasing when most of the free supply of the world's scrap and newly-mined gold was being absorbed by the Chinese. Appointing Raghuram Rajan as Governor of the Reserve Bank of India in September 2013 was almost certainly due to the urgency of wanting to get demand for gold in Indian under control since he and is currently the establishment man for the BIS.
He generally failed in the missions, and he was not renewed to his position for unknown reasons, other than him preferring to return to the calmer environments of being a Vice-Chair at the Bank for International Settlements and going back to academe.
This isn't typical for a central banker's career when he is at the height of his influence and powers. Perhaps Rajan realized that it would never work to try to manage gold demand and that Modi was becoming too dangerous for him to keep his legacy with the Reserve Bank preserved.
Recently he was quoted as stating that the ability of the RBI to tell the government no needs to be protected. This was several months after him declining the chance to serve his second term. One has to wonder whether this was a reflection of something that occurred.
The surprise money-grab made by the Indian government and State Bank of India authorities has served to intensify the public's perceptions of an ineffective, overly-bureaucratic and corrupt government.
The suspicion that the public has that the government's paper money will be worthless ultimately has gained a lot of credence. The most likely financial consequence of the move made by Mr. Modi is most likely the accelerating decline of the rupee's purchasing power, which will ultimately be destabilizing for his government and the country.
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