Gold Standard

Let's say, I earn ₹ 100k pm. My father used to earn ₹ 8k pm at my age (30 years ago). Am I better off or was he? 

Well, nominal values across time frames cannot be compared. They need to be adjusted for currency devaluation (aka inflation) to arrive at the real value. However, the method used to arrive at the rate of inflation makes it relevant for macro policy decision. Its applicability in micro decision making is questionable. Why so is a different subject. 

Is there an alternate method to ascertain real value of money across 30 years? One way is to use 'gold standard'. 'If ₹ 100k can buy the same amount of gold in 2020 as ₹ 8k would buy in 1990, they're equal. But the fact is that in 2020, I required approximately ₹ 160k (20x) to buy the same amount of gold as my father could have bought for ₹ 8k in 1990.

Though we refer to this as increase in the price of gold, it is in fact, reduction in the value of the Indian Rupee. In other words, INR has lost 95% of it's value in 30 years. 

The devaluation isn't visible in every item though. For example, wheat cost 225 per quintal in 1990 and 2000 (9x) in 2020. A Maruti 800 costed ₹ 1.2 lac in 1990 and costs a little less than ₹ 4 lac (4x) in 2020. But is it the same with education, healthcare, legal consultation, beauty treatment?  

Why did prices of all items not rise in the same proportion as gold? 

Prices are impacted by costs and costs have gone down over the years thanks to better management techniques, economies of scale, technological advancements and changes in lifestyles (thus demands). But there are other reasons for costs to go down - exploitation of human and ecological resources. In 2020, the farmer surely doesn't earn enough to sustain his family as he could in 1990. But free markets don't really care for this. They're driven by demand-supply equilibrium. Anyway, that is a topic for another discussion.

The question is, if nominal value of currency isn't good enough for measurement, adjusting it for inflation also doesn't make it reliable, is gold standard suitable? And what is relevance of all this? Read on.

Money has three functions - means of exchange, unit of measurement and store of value. As a means of exchange, currency is significantly superior to any other - barter, gold, silver, copper or anything else used prior to the invention of modern currency. In fact, now that we use electronic currency much more than notes and coins, currency is the best means of exchange ever invented. 

As a unit of measurement, however, currency seems unsuited to compare across time frames. Amongst the available options, gold standard seems the least inaccurate. But this is open for debate.

Let's come to the third function of money - store of value. Currency has, over the last few decades, proven to be the opposite of storing value - it has destroyed value. Imagine, if one were to stash currency notes in his mattress in 1990 and retrieve them in 2020, it would've lost almost all of its purchasing power! Gold does a much better job protecting purchasing power. In fact it enhances purchasing power. If you were to buy ₹ 1 lac worth of gold in 1990 and store it, in 2020 the same gold could have bought you a Toyota Fortuner instead of a Maruti 800!

How can we use this understanding to improve our family economics decisions? Let's explore.

Though gold is generally referred to as an investment asset, it would be more appropriate to consider it as a benchmark for investments. Any return on investment is less than gold ought to be considered as negative ROI. If we do so, how do various asset classes fare?

Let's begin with debt or fixed return instruments. The 10 year government security yielded 6.5% in 2000 and a fixed deposit with a bank offered an interest of 8.5% pa. Let's say you invested 10gm gold equivalent in a 20 year cumulative fixed deposit. In 2020, the maturity proceeds would have bought a little over 6 gm gold. Debt yielded negative 40% over 20 years.

Let's turn to equities. BSE Sensex was approx 5000 in the March 2000 and 49000 in March 2021. If I were to buy one unit of the BSE Sensex in exchange for gold, I would have paid 11.3 gm gold. In 2021, by selling that one unit of index, I would get back 10 gm gold. After 21 years, while the BSE Sensex has grown 10-fold, the return in gold terms is -13%. 

I am aware that this is not the most accurate calculation and that there have been stocks, which have offered higher returns. I'm not trying to prove that gold is a better asset class. My limited points are these

1. Nominal value of currency is deceptive in evaluating performance. It is more appropriate to use gold standard.

2. Devaluation of currency is likely to accelerate given government actions in most countries during the pandemic. Also continuing economic policies in the wake of rising political tensions will further devaluation.