Monetary Integrity and the Rupee

 

Monetary Integrity and the Rupee: Three British Raj relics have dominated our macroeconomic policy-making

First published in Business Standard 28 September 2008

 

Taxation via inflation “does not require detailed legislation, and can be administered very simply. All that it requires is to spend newly created notes. The resulting inflation automatically imposes a tax on cash balances by depreciating the value of money”. Philip Cagan said this in a pioneering 1956 study of hyperinflations worldwide. Britain’s Hugh Dalton observed how government deficits could be met by “use of the printing press to manufacture legal tender paper money” to pay government creditors either directly “with new paper money specially printed for the purpose” or indirectly “out of loans to itself from the Central Bank”. Milton Friedman and Anna Schwartz pointed to America’s wartime resort to inflation.

 

Government debt held by a central bank quickly filters through to appear as an asset in balance-sheets of commercial banks, causing expansion of bank-lending and hence of bank-deposits and broad money. After the attack on Pearl Harbour, the US Treasury could get from the Federal Reserve or commercial banks “any funds that it needed beyond those secured by taxation and by borrowing from non-bank sources”. America’s wartime banking system became “a mechanism for providing funds to finance government expenditure” — deposits grew because “bank buying of government securities increases bank deposits”.

 

In RF Harrod’s words: “There is a well-known aphorism that ‘bank loans create deposits’…. if the central bank has an increase of assets, whether through a gold inflow or its own increase of ‘lending’ (including the purchase of bills or bonds), some commercial bank will have an increase of assets of equal amount, in the form of claims on the central bank (deposits at it or notes issued by it) and an increase of deposit liabilities of equal amount to its customers”.

 

India has followed in peacetime over six decades what the USA and Britain followed during war. Our vast growth of bank-deposits in recent decades has been mostly a paper (or nominal) phenomenon caused by unlimited deficit-finance in a fractional reserve banking system. Policy-makers have widely misinterpreted it as indicating a real phenomenon of incredibly high savings behaviour. In an inflationary environment, people save their wealth less as paper deposits than as real assets like land, cattle, buildings, machinery, food-stocks, jewellery etc.

 

Almost 50% of annual public revenues in real terms may have been arising from inflationary finance in recent decades. To take a specific example, during Dr Manmohan Singh’s tenure as Finance Minister, Union Government expenditure net of operational income was some Rs. 1.3 trillion (Rs 1.3 lakh crore) in 1994-1995. Some Rs. 675 billion (1 bn= 100 crore) was raised from all taxation that year, Rs 183 billion from direct taxes. The remaining Rs. 620.8 billion was borrowed on behalf of future generations of citizens using the Government of India’s credit. What is termed “Gross Fiscal Deficit” is this additional or marginal annual borrowing — it adds itself to the ongoing stock of public debt every year and has been continually monetised insofar as our mostly nationalized banking system annually comes to hold government securities to that additional amount.

 

India’s inflation-history shows a first phase from the 1870s until the Second World War when money prices fluctuated in response to real shocks, positive and negative, domestic and international. E.g., the US Civil War and First World War caused demand surges for Indian manufactures like cotton textiles and steel railway-tracks, while the Great Depression saw Indian prices crashing with world prices.

 

During the Second World War, money prices in India rose at their fastest rate ever, caused by deliberate British policy to pay for war expenditure by printing money. The British resort to inflationary wartime finance saw the highest money supply growth rates in India ever to occur to date. This pattern came to be adopted and institutionalised by independent India’s socialist authorities, so there has been a third phase of steady inflationary finance from the 1950s until today, along with negative shocks like military and civil conflicts, droughts and oil price-rises, as well as happier developments like technological progress leading to growth of real income (see graph).

 

Two more relics from the wartime British Raj continue to dominate Indian macroeconomic policy to this day. One is unlimited spending on vast standing armies — our supposed adversary itself being a political remnant of the Raj with similar macroeconomic problems to ourselves. India’s army has some 19 divisions facing Pakistan, Pakistan’s army has 19 divisions facing India!

 

The other relic has been the Indian rupee becoming inconvertible as a world money ever since import quotas were imposed across the Sterling Area in 1940-1942.  Lack of convertibility has made all government finance in India unlike that in modern Western economies. US government bonds are held freely in foreign portfolios so a Swiss household or Japanese bank may trade these as they please. Bond prices vary inversely with interest-rates, and yield curves would be attempted to be defined reflecting the maturity-structure and state of expectations. Competitive arbitrage in international capital markets may succeed in ensuring government debt is priced accurately.

 

A central bank with a convertible currency sells debt to raise monetary interest rates and attract capital flows, buys up its debt to lower rates and cause capital outflows. Money growth unwarranted by real growth depreciates the currency under floating exchange rates; a partial export of inflation occurs under fixed-rates. Debt instruments are liquid near-moneys, and it is because US Government debt has been liquid that debt instruments of its sub-sovereign divisions like States or municipalities are almost as liquid. If sovereign debt is not liquid, nor will be sub-sovereign debt.

 

In India, bank assets may be liquid domestically but are illiquid internationally. Government debt is not held by domestic households as voluntary savings nor has it been a liquid asset held worldwide in foreign portfolios. The same holds *a fortiori* for debt issued by more than two dozen State Governments. “Mutual funds” created in recent years do contain government debt on modern principles of portfolio-selection but amounts involved are small. The Rupee achieving monetary integrity after more than six decades of governmental misuse would be indicated only when any ordinary Indian resident can freely hold or trade India’s money for foreign moneys or precious metals as he/she pleases. India’s economy and money can begin to move towards coherence and integrity only when we put to rest the three relics from the wartime British Raj which we unthinkingly have allowed to dominate our macroeconomic policy-making ever since.

 

The Excel graphs built on my data were made into a nice picture by Business Standard but seem to have been removed from their website, and hence are reproduced here now for the first time today, Oct 2, 2011:

 

See also, more recently,

India’s Money, 2012,

Critical assessments of India’s economic policy, plus my 3 Dec 2012 Delhi talk on India’s money, Interview on Lok Sabha TV 2012, GDI Impuls Zürich Interview, Sunday Guardian Interview & Asian Age/Deccan Herald coverage

 

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Govt of India: Please call in the BBC and ask them a question

The BBC has unilaterally decided that Jammu & Kashmir has nothing to do with India.  On its 1530 Indian Standard Time broadcast of purported “World News” today, it unilaterally lopped off all of J&K from the map of the Republic of India (shown attached to mention of a Delhi bomb-blast). Usually, the BBC at least makes pathetic reference to something it has invented called “Indian-Administered Kashmir”.

There are senior BBC staff-members who are dual Pakistani/British nationals and who may be counted on to have been pushing such a line within the organisation, but lopping off all of J&K unilaterally may be a novelty. There are several “Indian-origin” staff-members too but perhaps they have renounced their Indian nationality, and apparently they have no ability to make any editorial protest.

Does the Government of India have the sense, and the guts, to call in the local BBC and ask them for an explanation about their insult of history?   For that matter, what is the BBC’s formal position on the J&K  problem?  The same as that of the UK Government?  What is that of the UK Government for that matter?  Has it remained constant since Clement Attlee in October 1947?

BBC staff may like to refer to my articles “Solving Kashmir”, “Law, Justice and J&K”, “Pakistan’s Allies”, “History of Jammu & Kashmir”, etc for enlightenment.

Subroto Roy

122 sensible American economists

$700 billion comes to more than, uhhhm, $6,000 per income taxpayer in the USA.

I was glad to see the sensible letter of 122 American economists to US legislators regarding the Paulson-Bernanke plan to address America’s financial crisis.

Somehow, I have an inkling that foreign central banks have been left holding more bad US debt than might be remembered — which would explain the embarrassment of Messrs Paulson and Bernanke vis-a-vis their foreign counterparts… Dollar depreciation and an American inflation seem to be inevitable over the next several years.

Subroto Roy

MK Gandhi, SN Roy, MA Jinnah in March 1919: Primary education legislation in a time of protest

In March 1919, Indian politics were extremely tense over the draconian “anti-terrorist” law known as the Rowlatt Act.  On March 23, MK Gandhi called for the general strike or hartal on April 6 that came to be known as the Rowlatt Satyagraha (and was soon to be followed by the Jallianwalla Bagh massacre in Amritsar on April 13).  On March 28, MA Jinnah resigned his membership of the Viceroy’s Imperial Council  in protest  that  the Rowlatt Act had not been amended as demanded by the Indian members of the Council.   In midst of such tumultuous events, my great grandfather Surendranath Roy, on March 27 1919, seems to have quietly managed to get his  “Bengal Primary Education Bill” passed in the Bengal Legislative Council.

From India in 1918: A Chronological Record of the Phases of Developments in Indian Polity During 1918, HN Mitra (ed),  Annual Register Office, Sibpur, 1921.

October 1929? Not!

October 1929?  Not!
by Subroto Roy

First published in Business Standard, Editorial Page, 18 September 2008 www.business-standard.com

 

Lehman Brothers filing for bankruptcy protection, Merrill Lynch taken over by Bank of America, Fannie Mae and Freddie Mac and now AIG being nationalised by the US Government, Bear Stearns getting a government bailout, many thousands of low-quality loans going bad … Does it all add up to an American financial crisis in the autumn of 2008 comparable to that in the autumn of 1929? Even Alan Greenspan himself has gone on record on TV saying it might.

 

But there are overriding differences. Most important, the American economy and the world economy are both incomparably larger today in the value of their capital stock, and there has also been enormous technological progress over eight decades. Accordingly, it would take a much vaster event than the present turbulence — say, something like an exchange of multiple nuclear warheads with Russia causing Manhattan and the City of London to be destroyed — before there was a return to something comparable to the 1929 Crash and the Great Depression that followed.

 

Besides, the roots of the crises are different. What happened back then? In 1922, the Genoa Currency Conference wanted to correct the main defect of the pre-1914 gold standard, which was freezing the price of gold while failing to stabilise the purchasing power of money. From 1922 until about 1927, Benjamin Strong of the Federal Reserve Bank of New York adopted price-stabilisation as the new American policy-objective. Britain was off the gold standard and the USA remained on it. The USA, as a major creditor nation, saw massive gold inflows which, by traditional gold standard principles, would have caused a massive inflation. Governor Strong invented the process of “sterilisation” of those gold inflows instead and thwarted the rise in domestic dollar prices of goods and services.

 

Strong’s death in 1928 threw the Federal Reserve System into conflict and intellectual confusion. Dollar stabilisation ended as a policy. Surplus bank money was created on the release of gold that had been previously sterilised.

 

The traditional balance between bulls and bears in the stock-market was upset. Normally, every seller of stock is a bear and every buyer a bull. Now, amateur investors appeared as bulls attracted by the sudden stock price rises, while bears, who sold securities, failed to place their money into deposit and were instead lured into lending it as call money to brokerages who then fuelled these speculative bulls. As of October 22, 1929 about $4 billion was the extent of such speculative lending when Chase National Bank’s customers called in their money.

 

Chase National had to follow their instructions, as did other New York banks. New York’s Stock Exchange could hardly respond to a demand for $4 billion at a short notice and collapsed. Within a year, production had fallen by 26 per cent, prices by 14 per cent, personal income by 14 per cent, and the Greatest Depression of recorded history was in progress — involuntary unemployment levels in America reaching 25 per cent.

 

That is not, by any reading, what we have today. Yes, there has been plenty of bad lending, plenty of duping shareholders and workers and plenty of excessive managerial payoffs. It will all take a large toll, and affect markets across the world.

 

But it will be a toll relative to our plush comfortable modern standards, not those of 1929-1933. In fact, modern decisionmakers have the obvious advantage that they can look back at history and know what is not to be done. The US and the world economy are resilient enough to ride over even the extra uncertainty arising from the ongoing presidential campaign, and then some.

Milton Friedman’s defence of my work

Twenty years have passed since the acceptance of my book Philosophy of Economics for publication — which coincided with the attack on me arising out of the very success of the India-perestroika and Pakistan-perestroika projects I had been leading  (an attack from within the University that had sponsored the projects since 1986).   I was graced with the support of two  of the 20th Century’s great economists, TW Schultz (1902-1998) and Milton Friedman (1912-2006).   Professor Schultz’s defence of my work has been published already.  Here is that of Professor Friedman.   Both  Professor Friedman and Professor Schultz were later expert witnesses on my behalf in a federal trial (a trial that unfortunately came to be marred by demonstrable bribery and perjury, yet to be rectified).

Addendum 23 Dec 2016:  the jury trial demanded 14 Feb 1990 has never happened; a bench trial with an admittedly compromised judge happened in 1992, marred by demonstrated bribery and perjury  https://independentindian.com/thoughts-words-deeds-my-work-1973-2010/my-american-years-1980-96-battling-for-the-freedom-of-my-books/become-a-us-supreme-court-justice-explorations-in-the-rule-of-law-in-america/

On Jimmy Carter & the “India-US Nuclear Deal”

I have always rather liked Jimmy Carter, who was President of the United States when I first went to Blacksburg from Cambridge in the summer of 1980.  It astonished me, perhaps because I was naiive, to find the depth of animosity against him among my American colleagues.  For example, I remember the late Wilson Schmidt (in one of several kindly gestures towards me until his untimely death) taking me to my first game of College Football — and there singing the Star Spangled Banner with the words “except Carter” added after “home of the brave”.   Of course it was the time of the Iranian hostage crisis which had then seemed to be a debilitating humiliation.

 

Jimmy Carter will need a good biographer to assess him properly, whether now or in years to come, and he may not get one; objective historians are simply too scarce, especially perhaps in America.  Certainly it was undignified of the Democratic Party not to give him any role whatsoever during the recent Convention appointing Barack Obama.

 

In the International Herald Tribune of September 11 2008, President Carter has said about the India-USA nuclear deal:

 

“different interpretations of the same pact can lead only to harsh confrontations if future decisions are made in New Delhi that contravene what has been understood in our country.”

 

 

I flatter myself to think he or his research-staff may have perhaps read my August 19 2007 article “Need for Clarity” available here where I said:

“The agreed text of the “treaty” looks, from a legal standpoint, quite sloppily and hurriedly written ~ almost as if each side has cut and paste its own preferred terms in different places with a nod to the other side…. Through the sloppiness comes scope for different interpretations. The Americans have said: try not to test, you don’t need to, we don’t test any more, and you have to know that if you do test, this deal is over, in fact it gets reversed. We have said, okay, we won’t test, and if we do test we know it is over with you but that does not mean it is over with others. Given such sloppy diplomacy and treaty-making, the scope for mutual misunderstanding, even war, remains immense long after all the public Indian moneys have found their way into private pockets worldwide. Will a future President Jeb Bush or Chelsea Clinton send F-22 bombers to bomb India’s nuclear facilities because India has carried out a test yet declined to return American equipment? Riding a tiger is not something generally to be recommended.”