10 thoughts on “The Current Account Deficit – The strange logic of Mr. D Subba Rao and Mr. P Chidambaram

  1. Aditya Sood

    Sir, I have a question. From what I understand, the value of a currency of a country used to be linked to its gold reserves in the past. The fractional reserve is a new thing. So who decided that value of a currency should be de-linked from an underlying commodity ? Was it that all countries saw some flaws in that system and decided to shift to a new one ? Or is it that one particular country/group of people enforced it upon the rest ? If yes, how did they manage to convince all the countries about shifting to a new system ?

    Also, when this delinking took place, did anyone (economists etc.) see any alarm bells ringing ?

    Reply
    1. Bala Post author

      Aditya,

      Actually, a proper reply to your question would be an entire article by itself. In fact, it would become an entire series of articles. For the moment, I will just mention that there are many errors of understanding that are visible in your question itself. Once these are corrected (which I will do in my next article), we can move on to the proper understanding. Do bear with me for a day or two as I am travelling on work.

      Reply
      1. Gurucharan

        SIr,

        Gold and Oil resources form nearly 40% of our import bill. Oil is something on which we cannot impose any compromises other than slight hike or drop in prices/ subsidies. But, gold is actually an unproductive expense for the economy. The more we import, more we hinder the scope of cashflow in the economy. According to economic statistics, almost 40% of the gold on world trade has been imported by India. By putting a stringent cap on this limit, can we foresee any fall in CAD?

        Reply
        1. Bala Post author

          The whole notion that something like gold is unproductive and hence that it is OK to restrict its import is flawed. People prefer to have gold. Period. Why they prefer it is not the province of economic theory. Further, gold and silver were selected as money commodities through market mechanisms. So, as money, they facilitate exchange. To do so, they have to be held first and then exchanged. As a medium of exchange, whether it is held or exchanged, it is extremely productive – it influences the mechanism of price discovery and the revelation of consumer preferences very well.

          Your mistake is also in seeing “cash flow” on what you consider “productive” as the proper goal of an economy. On this platform, you seem to think preventing other people from spending their cash on what they find most appropriate is OK.

          Putting a stringent cap on gold imports will only lead to gold smuggling. While there may be a temporary improvement in CAD, in the long run, more foreign currency will reach the hawala market and fuel gold smuggling. So there isn’t much anyone can do about it.

          Finally, the point of the article is that the entire question of CAD is a manufactured one. It is caused by the fiat monetary system with limited international currencies. Going back to a market determined system of money eliminates the problem of CAD once and for all. Attempts to retain the present monetary system and crying out loud about CAD is a good case of wanting to have your cake and eat it too.

          Reply
  2. jay

    I am not sure why no body else caught on to the real problem. The real problem is red tape..which is preventing foreign investment. Why is the govt scared to say, we will have a zero red tape policy. Create special economic zones like china and japan have done with no bureacracy involved, Make the rupee fully convertible. Just an announcement of such a provision coming – even if in the future will scare all the INR shorts; and bring in all the FII money.
    The indian govt instead is doing the exact opposite and expecting a favourable result. Reap what you sow.

    As a super simplified analogy, If you have a water tank(assuming it is completely sealed) which is low inwater level, has two pipes one inlet and another outlet….if you block the outlet, how can water come in?? Or…If you scare a kid from storing the toy in moms chest by saying if it goes in, it will never come out again, will the kid ever put the toy in moms chest?
    Mr chidambaram did the exact same thing – he said he will let money come in, but it cannot go out ( or has to go through red tape if it needs to go out). He even has the audacity to say it is not capital control.
    Whether the control is short term or long term, just the thought was scary enough to spook any foreign investor.
    Import control, capital control, currency conrtol, price control, rent control – none of them has ever worked. History says so. Infact it will do the exact opp. – which is that it cause the shortage of that commodity/service.
    Economy 101 imho.

    Reply
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