With reference to "Emerging markets should go for gold" (May 9), Kenneth Rogoff has suggested the central banks in emerging market economies (EMEs) should buy more gold. He gives some reasons but there are difficulties with his arguments. First, he writes, "... there is a case to be made that gold is an extremely low-risk asset with average real returns comparable to very short-term debt." This isn't true if we consider data in a research paper by Robert Barro and Sanjay P Misra on "gold returns" (National Bureau of Economic Research Working Paper No. 18759 in 2013).
Second, given that the long-term average real return on gold for more than two centuries is much less than the return on short-term bonds of creditworthy governments, it follows that a purchase of gold by central banks at this stage is likely to be followed by a sale at some stage in future. The purchase now can induce a higher price and the sale at a later stage can induce a fall in price. So the central banks' actions will likely induce gold price volatility in the medium term. Third, there is large demand for gold by the public in EMEs. The governments are trying to reduce this. In this context, it is important that central banks set an example and not buy more gold.
Fourth, and most important, gold is not the only alternative to forex reserves. Other safeguards for exchange rate stability include credit lines - options to borrow in the event of a possible crisis (Gurbachan Singh in an article in 2012 in Margin - The Journal of Applied Economic Research). The International Monetary Fund (IMF) has made such credit lines available in recent years at low prices. Indeed a few nations have already bought such options. There is hardly any stigma attached to these as they can be purchased in normal times. Such credit lines are very different from the traditional lending by the IMF, which have been rightly criticised.
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Second, given that the long-term average real return on gold for more than two centuries is much less than the return on short-term bonds of creditworthy governments, it follows that a purchase of gold by central banks at this stage is likely to be followed by a sale at some stage in future. The purchase now can induce a higher price and the sale at a later stage can induce a fall in price. So the central banks' actions will likely induce gold price volatility in the medium term. Third, there is large demand for gold by the public in EMEs. The governments are trying to reduce this. In this context, it is important that central banks set an example and not buy more gold.
Fourth, and most important, gold is not the only alternative to forex reserves. Other safeguards for exchange rate stability include credit lines - options to borrow in the event of a possible crisis (Gurbachan Singh in an article in 2012 in Margin - The Journal of Applied Economic Research). The International Monetary Fund (IMF) has made such credit lines available in recent years at low prices. Indeed a few nations have already bought such options. There is hardly any stigma attached to these as they can be purchased in normal times. Such credit lines are very different from the traditional lending by the IMF, which have been rightly criticised.
Gurbachan Singh New Delhi
Letters can be mailed, faxed or e-mailed to:
The Editor, Business Standard
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E-mail: letters@bsmail.in
All letters must have a postal address and telephone number