This is what RBI governor promises when you hold a Rs 500 note in your hand. But why does he promise to pay you…Is it a gift from him? ….or… is it his liability towards you ?

Each currency note is actually RBI’s liability towards the bearer of the note. All currency notes in circulation are shown in the liability side of RBI’s balance sheet. For our discussion, we will not bother about why RBI makes this promise. Instead, we will stress test Currency Notes as MONEY defined by conventional economics.

Academically, MONEY, to qualify as Money, must serve two essential purpose:

  1. It is a medium of exchange
  2. It is a store of value i.e. it is able to preserve the purchasing power

Keep the above two aspects in mind for rest of the article.

Rupee, Dollar, & Gold as a MEDIUM OF EXCHANGE

The currency notes in your wallet work well as medium of exchange. No doubt…but, only when you are making transactions within Indian political boundaries. Once you are in an overseas location, the rupee notes in your wallet lose this ability. Perhaps the foreign monetary system does not trust Indian government’s capability to honor its promise. On the other hand, US Dollars, Pounds and Euros are accepted without any hesitation. Which means they are a more powerful currency than INR.

How does GOLD fare on this criteria. Imagine you walk into a grocery store with MMTC certified gold coin of 99.99% purity. Would the shopkeeper accept it as a medium of payment? Naturally, he would hesitate as this is not a norm, and he would be concerned about purity of the coin. But you are in luck. There is a big jeweler adjacent to the grocery store. Just as you would walk into an ATM to draw some currency notes, you visit the jeweler to exchange for currency note after bearing some nominal exchange charges. So, with little effort, your gold coin is converted into cash ….just like an ATM card. Hence, we can say that quick convertibility of Gold into cash can help it work as a medium of exchange.

There was a time in history when Gold & Silver were accepted as legal tender. However, with evolution of modern economics, Central Banks around the world found better ways of controlling the money via paper currency. But, with centrals banks around the world printing money recklessly, the confidence in global monetary system is on the decline. As a result, several states in USA are now debating and contending to introduce Gold & Silver as legal tender for exchange. Since 2010, many states have abolished taxes associated with buying & selling of gold & silver. The state of Utah brought a major change in 2011. As per CNNMoney:

The big legal change in Utah is that the state tax code now treats gold and silver coins — issued by the U.S. Mint — as currency rather than an asset. That means no capital gains or other state taxes will be levied when the coins are exchanged.

(Read in more detail)

Rupee, Dollar, and Gold as STORE OF VALUE

What if you keep the currency note under the mattress and forget it for 10 years. You will discover that RBI’s promise still holds true (unless it was demonetized). When you go to grocery shop with same Rs 500 note, the shopping bag will be half full this time, thanks to inflation. Therefore, we can say that RBI’s promise will get honored but will lose its value over time.

For our discussion, lets concentrate on period since 1971. It was in this year when Gold Standard was officially abolished and US Dollar was announced as a Fiat currency. It was this year when Central banks were given power to print as much currency as they want, unless inflation goes out of control. Every time there was a recession or slow down, governments around the world often resorted to deficit financing or printing more currency.

On the other hand, you cannot print GOLD. It needs to be mined. The availability of gold is limited. As more and more gold is extracted from the mines, less and less is available for future. Also, the cost of discovering & extracting gold  has become way costlier. As a result, since 1971, US Dollar has lost 98% of its value in comparison to Gold. Indian Rupee has done worse and it has lost 99.53% of its value during the same period. (Gold price in 1971: USD 35 per oz, Rs 193 per 10 grams). Such massive erosion of purchasing power shows that the INR & USD are no match to Gold when it comes to store of value.

The current world economic order is in a bit of mess. Three major economic zones (USA, Europe, & Japan) are operating at near ZERO or negative interest rates. This is indicative of poor state of economic health in these region. Countries like Venezuela and Iran are bypassing US Dollar as the medium of exchange. Venezuela is paying Iran in Gold for its Oil. There are international voices which are challenging the hegemony of US Dollar. No one knows how things will evolve over next 10 – 20 years. But it is good to keep some gold as insurance against the follies of central banks.

J P Morgan once said in 1912 :
“Gold is the real money. Everything else is credit”

I think this is as relevant today as it was back in 1912.


By Sameer Rastogi

18 years of experience, PG in Finance and has delivered Wealth Management lectures at IIM Lucknow, IBS Gurgaon and IIPM Delhi. Contributed to various newspapers. Strength – Application of Economic fundamentals to Investment

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