[5]
An interesting fact has recently crossed the newswires, as India’s banking system is ready to start paying its clients interest [6] on physical gold.
The Indian Minister of Finance, Arun Jaitley, has revealed new guidelines for the financial system, and the proposed new rules are somewhat surprising, even though the minister had already hinted in an earlier speech that 'gold could become an even more important asset during his tenure'.
Banks would not only be allowed to count the gold as part of their cash reserve ratio, it would also count as an integral part of the liquidity ratio of the banks which is now based on bonds rather than hard assets. That’s an important step forward which should pave the way for gold to become a much more important asset in India’s financial system.
This shouldn’t really come as a huge surprise as the Indians have always been a little bit crazy about gold. India is one of the largest gold-importing countries and the yellow metal is used as a gift on traditionally important days such as weddings. As India doesn’t have a mature gold mining sector at all, the vast majority of the gold will have to be imported and this incentivizes smugglers to bring gold into the country without declaring it to the proper authorities.
[5]
Source: GoldchartsRus.com
It’s unheard of in this modern world that gold will effectively be earning an interest when deposited at the bank. By this move, the Indian banking sector implicitly confirms it considers physical gold to be a currency above anything else.
If gold would indeed be widely accepted in the banking system, it would activate a part of the 20,000 unused tonnes of gold [7] and this would reduce the pressure on the Indians to import gold.
[5]
Source: Goldprice.org
But there’s one critical flaw in this idea.
If one ounce of gold owned by family X is deposited at the bank, and the bank subsequently lends it out to family Y which was looking to buy gold for a wedding, where will the bank get the gold from to repay family X when it wants to withdraw its gold from the banking system?
Indeed, the bank will very likely use the gold deposited by family Z to ‘repay’ family X’s deposit. This system will work great in the beginning, but can you imagine what would happen if the majority of the clients are demanding their gold back from the banks? The bank will not be able to refund everybody and that’s the exact moment where this Ponzi scheme (and yes, this is a Ponzi pyramid) will come to a screeching halt.
It’s great to see banks will be allowed to count the gold as a part of their reserves but this idea definitely needs to be worked out before it gets instated as a system that would facilitate a Ponzi scheme in gold.
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