Tuesday, 3 April 2007

Farmer suicides, debt and inflation

On the first page of every NCERT book is Gandhiji's famous talisman:


I was reminded of this talisman when I looked at these hopeless faces (please, take a look) of farmers demonstrating in Janter Manter. They come from , all over the country to talk about the problem of 'karza' (debt) which has blighted their lives. Debt leaves them so vulnerable to destitution that many of them are driven to suicide in despair and hopelessness.

I asked myself, are these not the faces Gandhiji asked us to think of? Can the talisman be applied to our monetary policy so it gives these people hope and security?

Our money - the Indian Rupee

The Rupee is the legal tender for the country, which means that it is the only currency in which creditors can legally expect payments. Borrows are not legally required to repay debts in any other form (e.g. gold, silver, dollars, grain, pounds of flesh, etc.). This ensures that financial institutions such as banks and credit societies only extend Rupee loans to the general economy. Additionally, our Government expects tax to be paid in Rupees.

These legal reasons ensure that the Rupee becomes the primary, if not the only medium of economic exchange in the Indian economy. Other forms of payment, which would otherwise naturally gain currency simply do not - for two reasons.

First, credit extended in these forms of payment is not legally protected thus placing them at a significant disadvantage.

Second, any commercial transactions using them usually involves payment of taxes in Rupees rendering such transaction highly inconvenient.

So where do Rupees come from?

Step 1 - Creation of Money

Rupees come into existence as debt created by the Reserve Bank of India (RBI). The RBI has a legal monopoly on debt creation. This debt is multiplied through the banking system, and is largely consumed by high-earning (i.e., credit-worthy) companies or individuals. Rupees enter circulation when these individuals or companies acquire assets, or purchase goods and services.

Interest Rates

Like most 'growth-oriented' central banks, the RBI encourages increasing consumption of debt by lowering interest rates. Lower rates encourage individuals to borrow and acquire assets or spend money. Entrepreneurs take advantage of the cheaper credit to expand or start businesses. This new debt (money) enters circulation and stimulates demand for goods and services.

Note: It is important to understand that EVERY rupee comes into circulation as DEBT (karza) issued by the banking system. This DEBT must be repaid with INTEREST back to the banks. Since the interest MUST ALSO come from the same circulation, the debt can never be paid back fully. The interest can only be paid if all of us take on MORE DEBT from the banks!!

Eventually, our debt-based money supply MUST always result in defaults - since the banks cannot lend to us forever. So the weakest sections of society (such as farmers) and industry (leveraged or low-margain businesses) are forced to default on their debt. The effects of this are ugly - farmer suicides, foreclosures of houses, appropriation of industrial assets by the banks, restructurings, layoffs, etc.

DEBT-based money is widely confused with CREDIT-creation. Credit is deferred payment for consumption of goods or services and it is a useful for promoting growth and consumption. Credit can easily be created with an asset-backed currency such as gold or silver. Credit created with such currencies doesn't result in the odious side-effects described above.

Step 2 - Inflation

This debt-creation results in inflation of the supply of money in circulation. Had the production of goods and services neither grown nor become more efficient, the rate of money supply inflation would have exactly equalled the rate of price inflation (Note: By price inflation I mean the prices of ALL goods and services in EXACT proportion to their consumption, not the CPI and other misleading indicators used by the government). This is in strict accordance with normal rules of supply and demand.

Step 3 - Price Bubbles

This price inflation is reflected in either assets prices (e.g. stocks, property, tulips even :) ), or commodities (e.g. food, energy, metals), or both. This is because demand (money) for these is systemically created before the assets, goods and services themselves are created, regardless of whether they are ever created. Dynamic sectors of the economy (such as manufacturing and services) respond to this stimulus and create goods and services to satisfy the new demand, but other sectors like agriculture cannot grow as quickly.

A vast majority of our people are not able to participate in this growth (such as farmers and pensioners), because they cannot create new goods and services, for lack of ability or opportunity. In the face of price inflation they are squeezed by costs that grow faster than their incomes. They must must work harder and harder simply to maintain their living standards.

Step 4 - Inflation Targeting and the Bust

Eventually, inflation rises above RBI targets and becomes a concern. Interest rates are tentatively raised to try and curb price inflation. From unnaturally low rates we slowly go to unnaturally high rates. This puts a slow squeeze on the general access to debt for the economy. The economically vulnerable flounder while the affluent continue to borrow and inflate prices. Debt become more onerous for the weaker sections as rates go up and the 'karza' burden increases as the poorest find they cannot earn from other sections of society to the money to repay the debt.

Farmers start taking their lives, pensioners slowly descend into poverty, asset prices weaken and asset bubbles pop, hapless investors lose their savings in the stock or housing markets, businesses that were viable during low interest rate regimes become unviable and are shut-down leading to job losses, and the contagion spreads through the entire economy leading to a bust.

Exploiting the Weak

So we see that in the whole business cycle triggered by easy money it is the woes of the most vulnerable and most ignorant that are multiplied. The system is stacked in favour of the cleverest and most productive people - the unnatural boom-bust cycle in the economy is created solely by giving everyone access to cheap debt and then withdrawing it when prices rise.

This monetary system is the OPPOSITE of what Gandhiji's talisman tells us to do. We have chosen to create a system that causes economic disruption of the most wretched and vulnerable individuals and industries, through interest rate uncertainties, boom and bust cycles and inflation. Common decency demands is that if our monetary system cannot help improve their lives, we choose a system that, at least, does them no harm.