Allow me to invite you to participate in an interesting thought experiment on money.
In 1973, full 35 years ago, a pack of India Kings cost 5 rupees. Now, suppose that in 1973, you stored away 2 paper notes, each worth 5 rupees. The first was a 5 rupee note issued by ITC Ltd. promising to redeem the paper with a packet of Indian Kings on demand. The other note is the ordinary green Reserve Bank of India 5 rupee paper.
Both these notes were stored carefully in a safe in 1973, and taken out only today. What are they worth?
Well, for the ITC paper note you would still get a packet of India Kings, now worth 100 rupees.
For the RBI note you would get a bundle of bidis.
This shows why money must always be something tangible. Indeed, tobacco has been used as money even up to a few centuries ago. ITC notes redeemable in tobacco would always keep their value intact.
But what do we make of the RBI paper? Well, the best way is to consider it as a case of what ITC did not do – like the dog that did not bark in the Sherlock Holmes story.
Now, suppose ITC was not managed by gentlemanly “boxwallahs” and was run instead by corrupt upstarts like the cheats of Satyam. And they devised a scheme by which to defraud their note-holders. The scheme was as follows:
Over the 35 year period, ITC went about systematically lowering the quality of India Kings cigarettes. So, by 1980, there is no filter tip; by 1985 the cigarette is 10mm shorter; by 1990 the tobacco in the cigarette is exactly the same as in an (ugh) Wills Flake. And by 2009, when you redeem the IK Note all you get are a bundle of bidis with “India Kings” emblazoned on the pack.
Actually, we cannot imagine any reputable company doing something like that in an open market. All note-holders would be up in arms. ITC would be dragged to the courts.
Yet this is precisely what the RBI has done, quietly, silently, gradually. And no one has complained. And, what is worse, the RBI has a “good reputation.” Thanks to Keynesian “macroeconomics” killing all intellects.
The US Fed has done much the same. In Nixon’s time, 35 US dollars bought you an ounce of gold. Today, the same costs 900 dollars. If you stored 35 US dollars in a safe in 1971 and took the money out today you would probably get an ounce of iron. Gold turns to iron just as king size premium cigarettes turned into bidis.
This is the scandal that is fiat paper money. Combined with fractional reserves it is but a Ponzi scheme. A Ponzi scheme, that is, run by governments. And we thought that the role of The State is to uphold the Rule of Law!
My questions: Who should teach Law? And who should teach Economics?
Do you see the great error Indians have committed by asking our The State to occupy the “commanding heights” of Education? We must throw the rascals out of academia.
excellent piece!
ReplyDeleteVery nice way of explaining it. Will forward this to all I know. Thanks.
ReplyDeletenow this is so nice...
ReplyDeletesome q and A:
1)are the gold prices supposed to remain at a constant, say at the perfect situation?
2) increase in rates of india kings could also be due to a supply demand mismatch!
3) I sell my sauces at a break even price today, but i plan to increase the rates by 40% in next 2 years. strategy for penetration.
??
thanks
Gold prices cannot be fixed in a free market. Theorists say the price of gold will steadily rise - thereby bringing about the steady fall of all other prices.
ReplyDeleteThe increase in the price of India Kings is only inflation - the fall in the value of the rupee. Plus onerous taxation. Nothing else.
About your sauces. I don't know.
if you put the second note in the bank - would you today be able to afford a pack of India Kings? That may be a better yardstick of how the Rp has kept its value.
ReplyDeleteAfter all if you locked up a pack of India Kings in 1973 - and took it out now. It probably is worth (in taste to a smoker) less than a pck of bidi's
Very interesting. Could you continue? - I'd like to know how you think paper money should be managed. You would agree that moving back to a barter economy would not necessarily be optimal!!
ReplyDeleteThe only thing that matters is that the paper note should be convertible on demand into an asset, a commodity, something of true value - like gold, or tobacco. After all, nobody wants to give up anything of value for just paper. Irredeemable paper notes means giving up something for nothing.
ReplyDeleteSauvik, Would it not be critical that the asset or commodity be something that does not change its fundamental characteristic over time? Land or Gold come to mind as good examples; tobacco and the ilk fail because (as Aditya pointed out) they lose the characteristic that makes them tradable commodities with age.
ReplyDeleteNothing can beat the precious metals as money, it is true. But in history, there have been many other moneys - from cowrie shells to salt (the word "salary"), and from tobacco to deerskins (the word "buck"). In Nazi concentration camps, cigarettes were money - the preferred brand being Kent! Whatever is spontaneously accepted as money in exchanges becomes money in a free market. My example just showed how cigarettes are a better money than government papers based on nothing.
ReplyDeleteA very thought-provoking stuff... thanks!
ReplyDeleteBut in the real world, the note or coupon given by ITC is bound to have a validity date. Because even ITC knows that production costs are likely to go up and the price of the cigs will not remain constant. Or is that not the point and I am missing something?
ReplyDeleteVaruna, interestingly real cost goes down with time, enterprises having developed and adopted cost effective techniques and larger scale of production.
ReplyDeletehow do we take the time value of money into account? inr 5 left in a bank account with the 20 per cent plus interest rates in the 1980s and early 1990s...
ReplyDelete