TL:DR: Kotak wants to avoid deflation at all costs and is looking to further inflate the Rupee by monetizing Indians’ gold reserves.

Here’s the latest chart for Kotak Mahindra. As technical analysts would say, it looks “ugly” :

Now that the endgame seems near, Mr. Kotak has been tweeting about gold :

Let’s start with the basics here.

Does consumption create growth?

No. The only cause of economic growth in the first place is delayed gratification, saving, and investment, which extend the length of the production cycle and increase the productivity of the methods of production, leading to better standards of living.

If all we did was consume, and no one saved and productively expended any resources, the entire structure of production would grind to a halt. Just to maintain the structure of production involves saving enough to support the existing capital structure: all the stages and production processes from raw materials down to the finished product that constitute the intermediate stages of production that are left out of GDP.

Saving and investment is what allows for capital accumulation, which is what has raised us from a primitive existence to our present condition, where we criticize capitalism on miracle machines inside air-conditioned rooms.

We would advise Mr. Kotak to peruse a copy of this ebook for free. This is something a 5 year old kid should understand, but Keynesians are a special lot.

What is the difference between savings and investment?

Essentially, saving refers to methods of storing value whereas investment refers to methods of generating returns from capital.

Investments naturally imply a higher risk than saving. The idea behind saving is simply storing value and protecting it from inflation. If you can do 0 risk saving, that’s great. That’s what gold does best. Sits and does nothing, but protects you from inflation at zero risk.

Why save in gold and not rupees ?

To protect oneself against inflation :

If the government wasn’t playing games with the rupee, there would be no need to “export domestic savings to import gold”. People would simply hold rupees, in hard cash if they did not want to take bank risk.

Is gold “unproductive” ?

No. Saving is nothing but differed consumption or investment. It’s not upto Uday Kotak (and surely not upto Modi’s Nirma powder) to decide when we come in to invest. It’s upto individuals, depending upon their time preference and risk appetite.

Is there a problem with people “hoarding” money to save?

Let’s imagine people were really “hoarding” cash and not consuming or investing. What would happen ?

Answer : The increased demand for money (which is a more neutral, less loaded way of describing “hoarding”) has the result of increasing the purchasing power of everyone else’s money.

If they people money, do not enter the market with it and just roll around in it, that money is therefore not bidding up prices. Prices fall, which makes everyone else’s real incomes rise. So no problem!

So what is Uday Kotak’s problem?

In one word : DEFLATION.

As we saw above, when people’s demand for money increases, prices fall.

In the fiat money system, the problem is multifold. Firstly, the rush out of bad investments creates a demand for cash. In a second step, as banks create money out of thin air, the contracting demand for credit causes a reduction in the money supply, which further increases the value of money.

In a third step, governments step in and start the money printer, which does not necessarily increase investment but creates a flight into safer assets such as gold (protection against the money printer). The cash then becomes worthless.

As of now, despite the government’s best efforts, what the Indian economy is witnessing is a secular deflation in asset prices.

Is deflation a problem?

Contrary to what the Keynesian hacks which populate our universities tell you, deflation is not a problem at all.

In a pure market economy in which we only had natural monies like gold and silver, there would be a natural tendency for the price level to diminish – we would have what is called deflationary growth – because the money supply – money production tends to lag. In an economy based on very strong capital accumulation and technological progress, it tends to lag behind the growth rates of the real economy – that is of the production of goods and services.

Therefore in a natural economy, there prevails a tendency for prices to drop.

This is what the world had until World War 1 – by and large. So you can look
at the standard text books and economic history of the nineteenth century and you will find that while the price level generally diminishes.

Under a natural system, there is no such thing as inflationary growth. That is, a growing economy in the context of an environment in which prices rise – in which the price level rises – virtually never happens. What you do have is growth with either with a stable price level or with a shrinking price level.

Some of the highest growth rates in American history were realized – just as Chinese growth rates in the last third of the nineteenth century – under deflation. This was deflationary growth. So this is a natural element of free economy.

We really recommend that you take the time to watch this lecture on one of those days when the traffic makes you want to sit at home and pour yourself a big ‘un :

So then why is Kotak in trouble with deflation?

Another one word answer : LEVERAGE

In an inflationary system, you have a generalized rush into leverage. Less and less spending is financed out of equity – out of your own money – and more and more is financed out of the credit market.

In a fiat money system in which the central bank creates a positive price inflation rate, both the demand for credit increases and the supply of credit also increases. It’s a huge boon for the credit market – of course it is also a huge boon for financial intermediaries such as banks – commercial banks – and insurance companies – and also investment funds.

From the great Hulsmann :

Now you might say where does this money on the credit market come from. Everybody has an interest to take out loans but who provides the loans – well, in a fiat money system people have a very strong incentive also to invest in credit market related financial instruments. Because how do you save – it’s no longer worthwhile to keep your money in cash – because then you lose – so you need to choose forms of savings that will compensate you for the loss of purchasing power of the money unit.

So you need to buy something that increases in monetary value with the general price inflation – such as real estate – such as stocks – shares in companies – or you need to buy something that maybe nominally stays at the same value but is linked to a a revenue that compensates you for the
loss in purchasing power.

That is typically the case with credit market instruments – so you buy a life insurance. You put money on a savings account – so a bank promises you ‘we’ll pay you 1.5 percent – that’s great’. Of course 1.5% today is less than the price inflation rate so you still loose – but you lose less than you
would have lost if you had kept your money in cash.

When deflation finally hits, the concomitant drastic reduction of the money supply entails a corresponding decrease of money prices, which negatively affects all market participants who have financed their operations through debt.

The lower nominal selling receipts after the run do not suffice to pay back the debts contracted at the higher nominal price level of the past. This in turn jeopardizes the positions of many creditors, who when they do not get their money back cannot pay back their creditors.

In summary, debtors go under, and sometimes creditors go under with them. This is precisely what happened in the 2008 US banking crisis. Homeowners went under, and when enough of them did, so did the banks which had lent to them.

So, now what ?

This is not financial advice, but a handy slogan : Short Kotak, Long Gold !