By MADHUSUDAN RAJ on Mises India (extracts with ILR edits)
Many people ask me about what possibly can happen if Indian central bank RBI is abolished or it collapses under its own weight? The following write-up is a brief reply to such important questions. We in the Liberty camp, who talk about doing away with the statist central planning institutions like the central bank, have a responsibility of providing answers to such questions coming from concerned citizens who have lived their whole lives under this statist system and so they can’t think of any viable better alternatives because of their habit of thinking in the present system and their lack of imagination of alternative scenarios.
At the outset let me declare that the following discussion is purely a theoretical exercise on this important issue of how to replace the RBI with something better and moral. As we all know, future is uncertain and we don’t know how market will configure itself once the central bank is gone. Notwithstanding this uncertainty, by using sound economic theory and history we can definitely say few things about this issue.
How We Got Here
To understand what will happen if we abolish the RBI, we first have to quickly understand the present monetary system of India and the world. World over the monetary system in place today is the fiat paper currency standard which is monopolized by governments’ central banks. Since 15th August 1971, when the American President Richard Nixon closed the Dollar gold convertibility, our world economy is running on a purely paper fiat currency system. And the monopoly to print these fiat paper currencies lies with the central banks of various countries. In short, the control of money is in the hands of the governments and their central banks.
There is no check on how much paper currencies they will print because after 1971 they don’t have to back paper currencies with gold/silver supply, which were real money. The only practical check on the creation of these paper currencies is the threat of hyperinflation which can lose elections and power for the political masters of the central banks.
The primary reason governments around the world got rid of the gold standard is because it was an ultimate check on their profligate spending and size of the state. The modern democratic state started its journey some 500 years ago as a police state i.e., its primary function, as defined by its creators like Thomas Hobbes and John Locke, were to protect life, liberty and property of its citizens, and nothing else. But as time went by, this minimum state devised techniques to get out of the strict limits that its creators put on it in the forms of division of government in various competing branches or the constitutional limits etc. Slowly the police or night watchman state became today’s welfare warfare state. In modern times we find all facets of our lives controlled by the state. Nothing is untouched by it. And these multiple roles of welfare and warfare required huge amounts of resources for centrally planning the economy and society. Gold standard was coming in state officials’ way of grabbing more power and so they cleverly got rid of it; economists like John Maynard Keynes came to their help in this work. That started the systematic inflationary policy era in the late 20th and ongoing in the 21st century. That is where we find ourselves today.
Looking at the economic theory and history, very likely this fiat paper currency experiment is in its last stages now. Why? Because limitless inflation and debt accumulation must end one day in a crack-up boom as Prof. Mises discussed a century ago. So when this system will end, the transition process to another system will become inevitable whether we like it or not or want it or not.
Here we want to discuss a different issue of what happens to India if she decides to abolish RBI and fiat paper currency rupee. If somehow we can accomplish this task then the following things will likely happen:
We have to first know what type of monetary and economic system will replace RBI’s debt based currency system. If we assume that a gold or silver back rupee, and that rupee can be in a digital cryptocurrency form also but backed by real money gold and/or silver, provided by various banks will come into existence with a rapidly shrinking and vanishing state then we can see few things happening immediately:
International trade (open economy)
A gold/silver back rupee will be a sound money and so it will attract attention of international investors. The demand for rupee will likely increase vis-à-vis other currencies and so rupee’s value will appreciate i.e., it will become stronger against other currencies.
This in turn will make India’s imports cheaper. India is a developing or emerging market economy which heavily relies on imported raw material, finished products, technology and human capital for its growth. A strong rupee will thus accelerate India’s growth process. Imported technology and manpower (human capital), if we open up borders for foreign experts who will come to work in India because they will get paid in gold/silver backed strong rupee, then that will boost India’s human capital base. Accumulation of human and physical capital will accelerate India’s growth.
With imported technology and workers, Indian export industry will also become internationally competitive which will help boost its exports also.
Higher growth in India coupled with sound money rupee will result in lower price inflation, i.e., lower prices of everything, with time. Real prices of both consumer and producers’ goods will continue to decline and that will increase the standard of living of an average Indian. Remember, rising real income is real growth and progress and not rising nominal but declining real income as it always happens with fiat paper currency based inflationary system.
Rising standard of living will bring millions of people out of poverty. This will slowly start to reduce the huge income and wealth inequality in India. RBI is the main source of this inequality. When RBI prints rupees it gives that to government’s friends like corporate tycoons and they become rich while we all become poor because of resulting higher prices. Abolition of RBI will create a level playing field for all of us. Business tycoons will have to compete hard for their single penny profit. No private bank will risk giving them loans when their account books are so heavily indebted. Unless they do honest business and improve their account books, they can’t remain in the market.
Abolition of RBI will also result in end of business cycles in the Indian economy. RBI is the cause of the business cycles. By manipulating market rate of interest, it generates boom and bust cycles. With RBI no longer in existence, there is no one to manipulate the market rate of interest. Market forces of demand for and supply of loanable funds will then determine various interest rates in the economy which will aligned with the societal time preference and so allocation of resources between present and future production will take place according to consumers’ wishes. There will be no colossal wastage of precious capital stock of the economy and so our future income will rise faster.
Once the RBI is gone, the accompanying behemoth Indian welfare warfare state will also be gone with it. As I said above, governments do not like gold standard because it ties their spending hands. It brings fiscal discipline because governments can’t print gold out of thin air like paper or digital currencies. In the absence of money printing RBI and ensuing gold standard, government officials, i.e., our political masters, will have no other option but to wind down this behemoth state because now they can’t fund their profligacy via RBI’s money printers.
A rolling back of the state means economy will start to become more freer now. Markets will be finally lifted of all kinds of bureaucratic burdens and so life of people will flourish. Government will continue to shrink with every passing day because a truly progressing economy will finally expose the myth of necessity of the state for managing our affairs. People will realize that the necessary evil of the government isn’t really necessary! Absolute poverty will be gone, unemployment will shrink to its natural levels, there won’t be any business cycle so economy will only experience occasional fluctuations, which is normal for any dynamic system. War mongering by the state officials, like what we are experiencing today, will be a thing of the past. Ensuing peace will promote commerce with everyone which will further lift the standard of living of Indians.
A progressing resource rich India means strong Indians who can defend themselves from any possible external aggression coming from the neighboring nation states. If Indians want to protect themselves from any foreign threat, and this question also is frequently asked to me by people that without government who will protect us from Pakistan or China?, then they need to be rich/wealthy so they can defend themselves. Poor people, which Indians were and are rapidly becoming again under the rule of heavy centralized state which is enabled by the easy money policies of its central bank RBI, can never defend themselves. India is a poor country right now and so fighting wars for it is a very costly affair as any war will turn India into a giant heap of rubble and such war fighting necessarily requires inflationary policy of the RBI which will devastate the country completely. A gold standard will give Indians the resources which they can use to defend themselves against any external threat.
How to go back to the gold standard?
Converting rupee in a gold backed money isn’t that difficult. What is required is to first freeze the money supply to its current level e.g., if the total amount of notes and coins circulating in the economy at a given time of going back to gold standard is, let’s say, 15 trillion rupees then we freeze it at that level. Then we back this money supply with available official gold reserves with the RBI. RBI holds something like 550 tons of gold in present. To use this much ounces of gold to back 15 trillion rupees we need to revalue the gold price in terms of rupees i.e., gold prices must go higher to accommodate all circulating rupee supply. If we go back to gold standard at some old price then that will deflate the money supply and result in severe recessionary crunch in the economy like what happened to Britain when it went back to gold standard after WW I at the old parity price. To avoid this problem we revalue gold price by dividing total available money supply with available official gold reserves. The price of gold will be reevaluated into six or seven figures if we do the math here. Once this is done, people can go to banks and redeem their rupee notes in gold and that starts the gold standard era.
The above discussion is based on lot of assumptions and I must mention the important ones here. The most important of all assumptions is, all these changes will only come when the Indian population is ready for them. If their cultural values are in tune with the values of individualism and accompanying free market capitalist system then bringing such changes will not be a difficult task. But we know that is not the case for India in present. Indian society is a collective society which is ruled by tribal instincts of envy and personal relationships etc. India is a backward society. This is why it is quite possible that once the RBI collapses under its own weight, instead of bringing in the gold standard and free market capitalist system overall, the Indian populace will bring some other menacing system e.g., military dictatorship or something like North Korea. And if that happens then we all know the consequences.
Notwithstanding these assumptions, my discussion stands on its own ground. If the conditions I mentioned are met then those changes that I talked about above will follow. If conditions are not present then the theoretical analysis is not relevant for India but it is not wrong also.
There are many other details that I can trace but at this moment I think I have addressed the issue of abolition of RBI in enough detail to start the discussion. More such issues I will address in future.