In past couple of weeks, some news items, and market & economic trends have attracted my attention. All these news items & trends somehow reflect on the reflation trade that has dominated the global markets for past few months.

The rise in commodity prices in past one year is seen mostly a function of a combination of demand and supply side factors. Post global financial crisis (GFC 2008) the investment in new capacities had slowed down considerably. The economic lockdown due to outbreak of pandemic further curtailed the supply of many industrial commodities. The logjam at Suez Canal further impacted the supply chain. The supply of commodities obviously could not match the recovery in economic activity as the economies began to open up.

The trillions of dollars in pandemic related stimulus further boosted the demand, as all three activities, viz., consumption, capex and trading got boost from worldwide stimulus. The US government’s plan to invest US$1trn in building nation’s deteriorating roads and bridges and fund new climate resilience and broadband initiatives is also expected to lead the further rise in demand for industrial commodities like steel and copper.

1.    A newspaper reported that HDFC Bank has received Rs300bn in prepayments in the quarter ended June 2021. These prepayments were reportedly made primarily by the companies in commodities and infrastructure sectors.

2.    A famous Kolkata based investment manager publically made a very persuasive case for investment in a public sector steel company, implying that in the given circumstances the share price of the company could potentially see a 3 fold rise in next one year. He also claimed that their portfolio schemes are presently invested in all metal stocks.

4.    The analysts at Phoenix Capital Research noted that “One of the key drivers of stocks prices since the March 2020 bottom has been the Fed’s interventions. The Fed spent a total of $3 trillion between March and June 2020. It briefly dipped between June and July 2020 but has since increased at a steady pace courtesy of the Fed’s $120 billion per month Quantitative Easing (QE) program.

However, all signs point to the Fed reducing these interventions going forward. With jobs numbers like those from July (900K+ jobs were created), the unemployment rate down to 5.4% again, and inflation roaring (CPI is clocking in over 5%), the Fed is effectively out of reasons to continue its month interventions at the current pace. Add to this the fact that numerous Fed officials are calling for a taper to QE and even rate hikes, and it’s clear the Fed is on the verge of announcing that it will be reducing its money printing very soon.”

It is pertinent to note that the GDP estimates for another large economy (India) have also been revised downward at least twice in past 4months, by almost all global agencies.Obviously, this cannot be good news for the traders staking their money on continuing reflationary trade.

The International Energy Agency (IEA) cut forecasts for global oil demand “sharply” for the rest of this year as the resurgent pandemic hits major consumers, and predicted a new surplus in 2022.

The announcement led to sharp correction in crude oil prices to the three months prior levels.

7.    The last move of about half of emerging market central bankers was hike in policy rates or policy tightening. Obviously, the days of monetary easing are behind. This shall definitely check the runaway inflationary expectations and therefore impact the reflation trade. 

8.    A BollombergQuint report highlighted that “Indian companies are running out of room to absorb rising raw material costs, which could force the central bank to unwind stimulus faster-than-expected and threaten a stock market rally that has earned billions for investors. Companies from the Indian unit of Unilever Plc to Tata Motors Ltd., the owner of the iconic Jaguar Land Rover, are increasingly complaining about pricier inputs and are frustrated at not being able to fully pass on costs to consumers reeling from the pandemic-induced economic shock. But it is only a matter of time before the pass- through happens, warn economists.

While its a tough balancing act, companies are mindful that something will have to give in eventually. In this case, it could mean higher prices being passed to consumers gradually as a recovery gets stronger in Asia’s third-largest economy.”

10.  Earlier this week, the US Senate gave bipartisan approval to a US$1 trillion infrastructure bill to rebuild the nation’s deteriorating roads and bridges and fund new climate resilience and broadband initiatives.

The plan reportedly includes, US$550 billion in new federal spending, to expand high-speed internet access (US$65bn); build/rebuild roads, bridges, etc (US$110 billion); airports (US$25 billion); and the most funding for Amtrak since the passenger rail service was founded in 1971. It would also renew and revamp existing infrastructure and transportation programs set to expire at the end of September.

11.  Back home, financials have are sharply outperforming the commodities since past three weeks. The market is telling that metals, sugars etc. have reached their peak margin and peak valuations. Using the strong price cycle, many large commodity companies have repaired their balance sheets. Consolidation by way of IBC process has also helped the larger companies. It is time that these companies may be thinking about the next capex cycle. Sugar companies have already embarked on a major capex cycle to set up new ethanol capacities. Steel companies are already planning major capacity additions. As per media reports SAIL is looking to expand capacities by 12-14 mt at its steel plants at Bokaro and Rourkela.

The popular inflation hedge trade (gold and silver) has done much worse than the overall commodity universe; whereas Bitcoin (perceived to be one of the most riskiest and volatile asset presently) has done very well.

Conclusion

These are still early days to conclude anything from the above cited news items and trends. Nonetheless, in my view, the following deductions from viewpoint of investment strategy may be considered reasonable:

·         The sharp run up in commodity prices is factor of supply constraints and demand stimulus. There are indications that supply constraints may ease as economies open up further; demand may cool down as monetary stimulus are gradually withdrawn and pent up demand subsides.

·         The commodity price inflation is now testing the limits of the industrial consumers (manufacturers). Any further rise from here shall be passed on to the last consumers, who would have much lower absorption capacity in absence of further stimulus checks. It is reasonable to assume that normal demand supply equilibrium will settle at a lower level only.

·         The balance sheets of commodity and infrastructure companies have seen substantial improvement in past one year. These two sectors accounted for more than half of the stress in the banking system. Besides, the credit growth is likely to pick up as companies rush to augment capacities to meet the increased demand and avail new government incentives for manufacturing sectors.

·         The conventional wisdom suggests that now it’s the turn of financials and capital goods manufacturers to do well. Commodities can wait for FY24 to have their turn again.

On the eve of 75^th Independence Day when you buy a plastic Tricolour from a young child on the traffic signal, would you (a) pause to think that this flag may be of Chinese origin, (b) buy with the idea of helping the poor child; or (c) just buy to demonstrate your feeling of patriotism?

In the post-independence period, the Indian economy has been persistently suffering from a variety of deficits. Though in the financial market parlance the twin economic deficits, viz., current account deficit and fiscal deficit, have been discussed most, these could be the least of worries for Indian economy in the current circumstances. Some of the most worrisome deficits, in my view, include:

·         Growth capital deficit

·         Advanced technology deficit

·         Skill deficit

·         Trust deficit

·         Compliance deficit

·         Governance deficit

·         Productivity deficit

·         Social infrastructure deficit

·         Employment opportunity deficit

·         Demand deficit

On the eve of 75^th Independence day it is important to appreciate that to successfully achieve the objective of self-reliance, as being popularly understood, we must first bridge this multitude of deficits.

Not many people may like hearing this, but the fact remains that in recent years China has been helpful in bridging many of these deficits, especially growth capital, technology, productivity, employment opportunities and demand deficits. Chinese investors have invested millions of dollars in Indian start-ups by way of risk capital. Chinese have supplied affordable solutions in the areas of energy, transportations, chemicals, healthcare, etc. Affordable Chinese consumer imports have created huge employment opportunities for millions of self-entrepreneurs, traders, street vendors, and aided in creation of demand, especially consumption demand. Of course, all this has not been gratuitous on the part of Chinese enterprise and administration. Nonetheless, it has helped to a great deal.

We must pause here and assess that since due to legacy issues we always have a wide and deep trust deficit with China, was it advisable in the first place, to let Chinese and Indian economic interest intertwine so much?

Keeping the jingoistic nationalism aside, we must also consider that the non-essential toys, plastic decorative items, small appliances & tools which are more visible and talked about items, constitute a miniscule part of the total imports from China. The imports are dominated by electronics, engineering products & components, agro chemical, specialty chemical, medical equipment, precious metals and Iron & Steel. Our main exports to China include Cotton, gems & jewellery, copper, ores, organic chemicals. China is therefore present in our entire value chain.

Disengagement with China in markets therefore has to be equally strategic as in case of borders. We cannot and should not do it overnight by taking some whimsical, but popular, decisions. We need to have a strategy to fill the deficits by alternative means and render China redundant before disengaging ourselves. Self-reliance in this context would mean, building capacities in the fields of advanced technology, raising the level of skill, compliance and governance to attract adequate amount of growth capital, raising productivity to enhance savings potential for domestic funding of growth; and bridging the trust deficit between the people and the administration.

This endeavour would inevitably include bringing India into a state of equilibrium by removing social, and regional, economic imbalances, e.g., through-

·         Industries and businesses who have thrived historical on government largesse and not necessarily on the enterprising abilities of promoters giving back to society by way higher taxes, higher voluntary CSR spending, technology upgrade for better resource utilization, etc.;

·         Regions like Gujarat and Maharashtra, which are economically more developed despite not being endowed richly with natural resources, acknowledging that a part of their development is due to imperial designs of British regime and share their wealth with exploited regions like Jharkhand and Odisha;

·         Caste and communities which command ownership of the major part of economic resources and occupy most of the social space, voluntarily vacating some space for the historically oppressed and downtrodden;

·         Populace which has grown to be non-compliant by habit, not necessarily by intention, changing habits like spitting on roads, violating traffic rules, encroaching on pavements in front of their house/shops, exploiting domestic helps and child labor etc.;

The 27yr old Australian swimmer Emma McKeon has won seven medals (4 Gold and 3 Bronze) at the Tokyo Olympic 2020. Overall, she has won eleven Olympic medals (5 Gold, 2 Silver and 4 Bronze).

In comparison, India has won 35 Olympic medals (10 Gold 8 Silver and 17 Bronze) in the history of modern Olympic. The first medal for India was won by Norman Pritchand - who won two silver medals in Men’s 200m and 200m hurdles at Paris 1900, 121yrs ago. For next medal, we had to wait 28years when Indian men’s hockey team won gold at Amsterdam in 1928.

After 1928, India won medal in the Men’s hockey event for next ten successive Olympics till Munich 1972. The only other medal during 1900-1972 was won by K. D. Jadhav in bantamweight wrestling (Bronze Helsinki 1952). Our contingent returned without a medal from Montreal in 1976.

Post Moscow 1980 Gold in the men’s hockey, India failed to win any medals till Leander Paes’s tennis Bronze in Atlanta 1996. We have won medals in each Olympic since 1996. Our best performance so far has been in Tokyo 2021 ( 1 Gold 2 Silver and 4 Bronze).

Eight of the ten gold medals have been won by India in the men’s hockey event (the 9th being in Air Rifle Shooting by Abhinav Bindra in Beijing 2008 and 10th by Neeraj Chopra for Javeline throw in Tokyo 2021). Other medals have come in Shooting (4); Boxing (2); Badminton (3); Weightlifting (2); Wrestling (7); athletics (2); tennis (1) and hockey (4).

I have been observing for past four decades that we as a nation start with extreme hopes and excitement three months prior to the Olympics. Media, corporate houses and now politicians also, make all efforts to raise hopes and expectations of billion people. However, by the end of the games, most of the excitement fizzles outs; hope turns into despair; criticism overtakes the appreciation; media and politicians move on to the next high TRP story; and sports enthusiasts mostly get back to their routine life after throwing few sacks of suggestions and advice for the sportspersons and sports administrators.

This cycle gets repeated for every major sporting event (including cricket) without fail. This raises two questions in mind that relate to politics and philosophy of sports:

Politics of sports

In past two decades (particularly after advent of IPL), sports has emerged as a large industry with huge employment potential. More important, sport is becoming increasingly democratized, allowing large number of people from underprivileged sections of the society (a fertile political constituency) to participate. Looking at the profile of successful sportspersons in recent years, it is evident that many sportspersons with modest socio-economic background have excelled in their respective sporting disciplines.

A lot of clamouring, financial support and other efforts are made to make athletes competitive at the international level. These efforts have certainly yielded good results in past two decades. With larger corporate participation, the sports infrastructure in the country is improving materially.

A number of sportspersons have performed well at the international level. Anecdotal evidence would suggest that one successful athlete might motivate 100k more to join the race.

The reluctance of the government in formally declaring sport as an industry is however baffling.

Philosophy of sports

Various societies in the world could be divided into two broad categories - (a) Ladder societies; and (b) Cliff societies.

The ladder societies are usually upwardly mobile societies. In these societies all get support and an equal chance to move up step by step. The place at the top is strongly believed to be infinite; therefore, the competition in these societies is mostly internal - people compete with their frailty, depravity, fear, and vices like lust, anger, greed, haughtiness, and infatuation.

Peace, asceticism, abstinence, benevolence, goodwill, spiritual evolution are some of the key words in these societies.

Cliff societies on the other hand are usually static societies. The core belief of these societies is that the place at the top is limited. The competition in these societies is therefore mostly external and fierce. To stay at the top, one must (i) stop others from climbing higher; (ii) be vigilant about those who have already reached the top, as they may try to push you down; and (iii) be consistently at fight with the peers and try to throw them off the cliff to secure your space at the top. Considering the intensity of the external conflict, the internal malice in these societies could remain unattended for unusually long periods of time.

Animal spirit, killing instinct, survival of fittest, relative competitiveness, material comfort, economic evolution, are a few of the key words in these societies.

All modern global sporting events, like global industry & commerce, have evolved in the cliff societies. These promote relative competitiveness as key sporting objective. The necessity to win medals incites the "animal spirit" and "killing instincts" in the participants. Unfortunately, this animal spirit and killing instincts do not die at the podium. These stay with the participants for long and impact their personal, social and economic life.

Moreover, this concept of "relative competitiveness" (also known as first past the post) is a major impediment to the quality in life, as the focus remains on doing better than the competitors rather than doing best for the self and the society.

Traditionally, India had been a ladder society. The concept of Ram Rajya is used to outline the tenets which promote absolute quality, equality and harmony in the society, permitting each individual to pursue his/her own chosen path with passion and dignity. Winning Olympic medals does not fit into traditional Indian ethos, but excellence in sports does.

Actually, traditional Indian businesses were also based on individual/social excellence (arts and crafts). The entire R&D effort remained focused on upliftment of entire society rather than profiteering.

But as the episodes involving wrestlers Sushil Kumar and Narsingh Yadav etc. show, a part of our society might be transforming into a cliff society fast.

More and more of our sportspersons are getting closer to international medals and trophies. Of course we will start winning more of them in next decade or so. More of our businesses are becoming globally competitive now. The natural corollary is that we would see more businesses getting crushed or gobbled by these large businesses over next few decades. Unfortunately, besides numerous cases of abrupt bankruptcies and hostile takeovers, we shall also see many more cases of road rage, domestic violence, divorce, back stabbing amongst professional colleagues, etc.

The idea is definitely is not to undermine the effort and achievements of the sportspersons playing for the country. It is also not to suggest that participation in competitive sports makes people aggressive and violent.

The benchmark Nifty 50 crossed the 16000 mark for the first time this week. Predictably, the moment was celebrated by media and “market influencers” with gaiety and fervor that is usually shown at Nifty50 crossing every subsequent thousand (K) mark. The fact that from 10k to 11k - it is a 10% rise; whereas from 15K to 16K it is just 6.67% rise, is usually disregarded in celebrations and recounting of the journey from one ‘K’ mark to the next “K’ mark.

It is also mostly ignored that Nifty, like any other statistical number, is meaningless in isolation. It must be juxtaposed with some “other” statistical number to derive any inference. The selection of this “other” number, however, usually depends upon what the data user wants to conclude. If the user wants to feel good about the current Nifty number, a comparison with an inferior set of statistics is preferred (e.g., Nifty has performed better than gold over past decade); whereas if the user wants to show the current Nifty number in a poor light, a superior set of statistics may be chosen to compare (e.g., Dhaka DSE30 has outperformed Nifty50 by 150% over past one month).

However, if the idea is just to celebrate, like drunk dancing in the wedding of a distant relative, a statistical number may be used in isolation.

Nifty: Drunk dancing in a wedding

In past 25years, Nifty return pattern has been quite erratic. From one ‘K’ to the next ‘K’ view point, there have been three instances of very fast journeys (2006-08; 2017-18 and 2020-2021); and there have been two long journeys (1993-2003; 2008-2015).

But this data may actually mean little for an individual investor, considering that-

·         The average vintage of investors in Indian market may be less than 15years;

·         There have been four massive draw down of over 25% each in these 25yrs, where many investors may have given up with little or even negative returns;

·         The point to point return in Nifty from any randomly selected date means little for individual investors. It is the actual return that matters;

·         Anecdotal evidence suggests that maximum investors take or increase their equity exposure in the rising market only. The largest inflows by household investors are usually seen during the last phase of an up move. Also, the exposure of household investors to Nifty ETFs is not significant, so change in Nifty value may not actually reflect the return earned by an average household investor; and

·         Most household investors prefer to invest in mid and small cap stocks with ‘multibagger’ return potential. The rate of failure in this segment is extremely high. There is decent chance that most household investors have underperformed the Nifty returns over this period.

For a majority of the household investors, therefore, celebrating a milestone in the 27yrs journey of Nifty is mostly like drunk dancing in the wedding of a distant relative. It gives a momentary high, dirty cloths and a painful hangover, the next morning.

Good, Bad and Ugly

The Good: Increased household participation in equity investing is a good sign for everyone – corporates; investors; market participants and the government. The channeling of household saving to productive sector, against negative real return yielding deposits or unproductive assets like gold is always welcome.

Another good thing to note about Indian equities is that Nifty has outperformed the global peers in INR as well as USD terms during past 12 months.

The Bad: However if we accept that (a) most of the household investors were already fully invested in March 2020; (b) the new investors have not made meaningful allocation to equity and are just testing waters; and (c) A large number of investors have withdrawn money from mutual funds and other professionally managed investment scheme and invested directly in equity (as indicated by the data of larger retail participation in daily trading activity and persistent outflow from mutual funds over past 15 months) .then we could easily assume that not many investors have made 100% return from the lows of March 2020, even though most of those who stayed invested through panic would have been saved from losses and made decent return on their investments. Also it would be reasonable to assume that the current portfolios of many investors are dominated by stocks with relatively poor quality of balance sheet, earnings profile and sustainability.

The Ugly: The ugly part is that the small and midcap stocks have massively outperformed the benchmark since Pandemic lows of March 2020. Not all small and midcap stocks are poor quality. But a large part of these stocks are either poor quality or represent highly cyclical businesses. This kind of divergent performance has usually ended disastrously for investors. As of now, there is no reason to believe it will be different this time.

Nifty returns vs Investment returns

We can put the Nifty returns in perspective by taking example of these two household investors ‘A’ and “B”.

Investor A is an ideal investor. He is 40yrs old; started investing in 2006 (Nifty 3966) when he joined his first job; has a portfolio that is mostly aligned to Nifty (mostly large cap funds and some direct equity); invests his surplus savings (Rs5,00,000/year) at the end of every year; and has not sold anything in 15years.

After 3 full market cycles, this investor would have earned a return of 11.55% CAGR as of today. The rate of change in Nifty in this period is 10.13% CAGR.

Investor B is also a household investor, 40yrs old, started investing in 2006 (Nifty 3966) when he joined his first job; has a portfolio that is mostly aligned to Nifty (mostly large cap funds and some direct equity); invests his surplus savings (Rs5,00,000/year) at the end of every year; but is not as disciplined and confident as the Investor ‘A’. He easily gets influenced by the forces of greed and fear – sells during panic and buys in euphoria.

He started in December 2006 and exited in December 2008 (post Lehman); redeployed the sale proceeds and new savings in December 2010 (Post QE) and exited in December 2016 (post Demonetization); again redeployed in December 2017, did not get panicked in March 2020, and is still invested. This investor would have earned 7.9% CAGR on his investment, though his net principal amount invested is same as Investor ‘A’. (For the sake of simplicity, dividends and cost of investments have been ignored in these calculations)

Nifty returns: A realistic expectation

The jargons like long term and short term are frequently used by the market participants, without providing any context to it. This jargon may have entirely different connotations for different set of investors. For taxation purposes, it refers to less than 12 months (Short term) and more than 12 months (long term). For risk capital investors (VC, PE etc.) this may relate to life cycle of a business; and for stock traders it may a technical swing lasting between few weeks to few months. Also, for a portfolio (diversified mutual fund etc.) investor this could be different than the investor holding a direct stock.

If for the sake of simplicity, we assume long term to mean 5 calendar years, Nifty returns (rolling 5yr CAGR) were very volatile for first 20years (1995-2015). Since then the volatility has reduced materially, with this number stabilizing close to +/- 12% range. This is despite poor economic growth and large drawdowns on demonetization, GST, Covid etc.

While equity markets do enjoy better attention of investors, it is the bond market that usually guides the direction of financial markets, including equity and currency markets.

The following recent signals from the bond market are worth noting:

US Junk Bond Yields fall below inflation

Investment demand for speculative-grade debt and high-yield bond exchange traded funds has been so high that yields on the riskiest U.S. companies are now below that of inflation. The rally in corporate debt rated below investment grade has also pushed yields down to record lows around 4.54%, compared to consumer prices that rose 5% in May year-over-year.

The head of equity research at Julius Bär, summarized the situation as “Inflation has risen to record-high levels in recent months, and the 10-year US bond yield has fallen to a fresh five-month low. What is the reason for the rally in US Treasuries? Obviously, investors believe that peak growth and peak expectations are already behind us. The US Federal Reserve’s (Fed) shift towards earlier-than-expected rate hikes has removed fears that inflation may run out of control, and falling purchasing managers’ indices from record-high levels support the case for decelerating economic growth. This is a normal mid-cyclical consolidation driven by base effects and most likely set to continue at least until Q1 2022.”

India: Credit risk category outperforming

In India also in past one year, the riskier corporate bonds have yielded best return as compared to the highly rated corporate and Sovereign bonds. The five year return on credit risk funds was less than half of highly rated corporate bonds and gilt.

These trends clearly indicate that bond market is not buying the theories of immediate full recovery to pre Covid level; sustainable higher growth, hyperinflation and imminent rise in borrowing cost.

 “The afternoon knows what the morning never suspected.”―Robert Frost

In past few years, cryptocurrencies (especially Bitcoin) have gained material importance in the global financial system. Though the character of Bitcoin (or cryptocurrencies for that matter) is still evolving and it is not certain if it will assume the character of a currency; end up just being a collectible asset like Art, wine, vintage vehicles, old coins, etc.; or just end like a bad dream. But as of now, the debate over its relevance, sustainability, desirability, etc., is intense and wide.

In my view, it is a debate that will continue for many more years and no one will remain unaffected by it. Almost everyone who transacts in money or is part of the global economic system will need to deal with at some point in time.

Majority of experts still skeptical

A large number of prominent personalities in the field of finance, technology and economics, like Warren Buffet, Jamie Dimon, Peter Schiff, Paul Krugman, Bill Gates, et.al., have publically criticized the popularity of Bitcoins. In their wisdom they have chosen the terms like “fraud”, “rat poison”, “scam” etc. to describe Bitcoin. In India, the legendary investor Rakesh Jhunjhunwala publically vowed never to own Bitcoin.

The following statements of the legendry investor Warren Buffet represent the sentiments of the people who are skeptical about the sustainability of cryptocurrencies as a viable currency or asset class”

"It's not a currency. It does not meet the test of a currency. I wouldn't be surprised if it's not around in 10 or 20 years. It is not a durable means of exchange, it's not a store of value. It's been a very speculative kind of Buck Rogers-type thing and people buy and sell them because they hope they go up or down just like they did with tulip bulbs a long time ago." (2014)

"In terms of cryptocurrencies generally, I can say almost with certainty that they will come to a bad ending. If I could buy a five-year put on every one of the cryptocurrencies, I'd be glad to do it, but I would never short a dime's worth." (2018)

It is “probably rat poison squared”. (2018)

“I think the whole damn development is disgusting and contrary to the interests of civilization. Of course, I hate the bitcoin success… I don’t welcome a currency that is so useful to kidnappers and extortionists”. (2020)

 "Cryptocurrencies basically have no value and they don't produce anything. They don't reproduce, they can't mail you a check, they can't do anything, and what you hope is that somebody else comes along and pays you more money for them later on, but then that person's got the problem. In terms of value: zero." (2020)

Later, however, JP Morgan, disregarding the earlier comments of CEO Jamie Dimon, “admitted its mistake” rejecting Bitcoin as a scam and has shown inclination to accept the cryptocurrency as an attractive asset.

Eric Peters, CIO of Hedge Fund One River Asset Management, proclaimed (about Bitcoin) that "There Is A Vague Sense That Something Powerful, Apolitical, Transnational, Is Emerging".

In the meantime, Rakesh Jhunjhunwala, the legendary Indian investors who is often referred as Warren Buffet of India, was heard saying in a TV interview, "I won't buy it for even $5. Only the sovereign has the right to create currency in the world. Tomorrow people will produce 5 lakh bitcoins, then which currency will go? Something which fluctuates 5-10% a day, can it be considered as currency?"

Regardless of the extremely negative expert commentary, Bitcoin has not been termed illegal in any of the major economies in the world; even though some countries like China have imposed severe restrictions on transacting in Bitcoins. El Salvador has become first country in the world to accept Bitcoin as the legal tender.

Despite being most volatile, Bitcoin has remained one of the best performing “assets” in past couple of years.

The historical context

The work on developing as crypto currency started in early 1980s. The idea was to create a medium of exchange that is independent of any central authority, is based on trust and is accepted by distributed consensus. The process was formally commercialized in 2009 with release of Bitcoin, the first decentralized cryptocurrency. May be uncertainty over future of fiat currencies post global financial crisis (which led to printing of unprecedented amount of new money) prompted adoption of an independent currency as medium of exchange. Since then, the cryptocurrencies based on block chain technology have been gaining popularity. Presently, besides Bitcoin, over 6000 variants of crypto currencies are in vogue globally. Many central bankers have also expressed in using digital technologies to supplement the paper currency.

The present value of all cryptocurrencies in circulation is over US$1.6trn; out of which bitcoin alone accounts for about US$750bn. This compares with US$5.8trn of monetary base (M0) of USA). The average daily trading value of bitcoins alone is over US$23bn. It is clear that Bitcoin is emerging as a serious challenger to Gold as an alternative currency or medium for exchange of value.

Two large global corporations Tesla (again!) and Amzon have expressed the intent to accept Bitcoin as valid payment for transactions. This has further intensified the debate and softened some of the critics.

The Indian context

In Indian context, the money market regulator (The Reserve Bank of India or RBI) has taken a guarded view of cryptocurrencies. It has refrained from terming it as illegal. However, some attempts have been made to discourage the use and ownership of cryptocurrencies. The Supreme Court of India has disagreed with some of these measures, and paved the way for legal ownership of cryptocurrencies. However, the regulatory and taxation regime is still evolving and may take some time to get established.

RBI vs Supreme Court

RBI issued a circular in 2018 directing all entities regulated by it (Banks and NBFCs) not to deal virtual currencies or provide services for facilitating any person or entity in dealing with or settling those; thus virtually banning use of crypto currencies in India. The Supreme Court quashed the said RBI circular in March 2020, on the appeal of the Internet and Mobile Association of India, representing various cryptocurrency exchanges. The SC accepted the argument of the appellant that in the absence of any specific law banning cryptocurrencies, dealing in these is a “legitimate” activity; hence RBI’s circular banning these is untenable.

In August 2020 various media reports suggested that a “note” had been forwarded to the concerned ministries for inter-ministerial consultation to promulgate a legislation banning the use of crypto currencies in India. Reportedly, the inter-ministerial committee headed by the former Finance and Department of Economic Affairs (DEA) secretary, Shri Subhash Chandra Garg (who has been in news recently for criticizing the government for backtracking on reforms) had drafted the Bill of the law to ban the cryptocurrencies. In the meantime, as per various media reports, since March 2020 SC order quashing the 2018 RBI circular, the local crypto exchanges have reported as much as 20x trading volume growth and a significant increase in the number of signups.

The aggressive marketing campaigns by these ventures however are focusing on promoting Bitcoin ownership for vanity purposes, palpably as a substitute for gold.

NITI Aayog initiative on Blockchain recognizing its importance

In January 2020, NITI Aayog (the think tank of the government of India on policy matters), had released part 1 of the discussion paper on “Blockchain: The India Strategy”. The well-researched and well-presented paper unambiguously stated that the government recognizes the opportunity, importance and need for blockchain based crypto currencies.

The paper recognized that “‘Blockchain’ has emerged to become a potentially transformative force in multiple aspects of government and private sector operations. Its potential has been recognized globally, with a variety of international organizations and technology companies highlighting the benefits of its application in reducing costs of operation and compliance, as well as in improving efficiencies.”

It is admitted that “Blockchain is a frontier technology that continues to evolve. In order to ensure that India remains ahead of the learning curve, it is important to understand the opportunities it presents, steps to leverage its full potential and such necessary steps that are required to help develop the requisite ecosystem.” And “Blockchain technology has the potential to revolutionize interactions between governments, businesses and citizens in a manner that was unfathomable just a decade ago.”

The paper candidly admits that “Blockchain is seen as a technology with the potential to transform almost all industries and economies. It is estimated that blockchain could generate USD3 trillion per year in business value by 2030.”

Obviously, the government of India recognizes the potential, opportunity, need and importance of cryptocurrencies. However, it wants to tread with extreme caution. The NITI Aayog’s discussion paper notes that —

“Blockchain has been positioned as a revolutionary new technology, the much needed ‘silver bullet’ that can address all business and governance processes. While the promise and potential of blockchain is undoubtedly transformative, what hasn’t helped this technology, that is still in nascence of its evolution, has been the massive hype and the irrational exuberance promulgated by a bevy of ‘Blockchain Evangelists’.”

“Any transformative technology, in its initial stages of development, as it moves out of research / development phase to first few applications to large scale deployment, faces several challenges. Part of the problem is that such technologies are initially intended to solve a specific set of problems. Bitcoin, which has led to the popularity of decentralized trust systems and has powered the blockchain revolution, was intended to develop a peer-to-peer electronic cash system which could solve for double spending problem without being dependent on trusted intermediaries viz. banks. As Bitcoin started gaining prominence, the potential of underlying blockchain technology started getting traction. However, some of the early design features that made Bitcoin popular, primarily limited supply and pseudonymity, have become potential challenges in wide scale implementation of blockchain.”

(The NITI Aayog discussion paper “Blockchain: The India Strategy” could be read here.)

Bitcoin ticks most boxes

Given the nascent stage of evolution of block chain technology and crypto currencies based on it, the cautious approach is understandable. However, the caution must be pragmatic and should not transgress to typical dogmatic paradigm.

In my view, the real debate is whether the world needs an independent reserve currency for cross border transactions; given that the unmindful printing of fiat currency by the respective large central banks in past two decades has perhaps diminished the credibility of the popular global currencies USD and EUR.

A broad evaluation of Bitcoin (or any other widely accepted cryptocurrency for that matter) highlights that Bitcoin may meet all prerequisites of a good currency – e.g., medium of exchange, store of value and unit of measurement. As evident from the following evaluation table, the advantages of Bitcoin, as an evolved independent digital currency, outscore gold on some parameters. It also outweighs any fiat currency that is not backed by real assets.

Gold vs Bitcoin

For many centuries, Gold was the most popular currency – store of value, medium of exchange and unit of measurement. However, with evolution of paper currencies and metric system, the usage of gold as a medium of exchange and unit of measurement declined significantly.

In past couple of centuries, Gold has served as reserve currency whenever the paper currencies have lost faith of people due to a variety of reason, particularly high inflation and fiscal profligacy. It has also been used as such during transition periods in global strategic power equilibrium. However since end of Breton Wood agreement in 1971, gold has not been used as reserve currency. Post fall of Berlin Wall in 1989 the strategic supremacy of USA, and consequently USD, has remained mostly unchallenged.

The demand of gold as store of value is a deeply complex matter. In past gold had been a preferred asset to store value both during economic (especially hyperinflation) as well as political (including geo-political) crises.

In 1970s the world faced serious stagflation as the demand generated by post WWII reconstruction activities faded and Iranian revolution created a worldwide energy crisis. Gold jumped 10x in real terms during the decade of 1970-1980), to give back most of the gains in the following two decades.

Again in the decade of 2000s, as the dotcom bubble hit the global economy, interest rates crashed leading to sub-prime crisis that culminated in a major global financial crisis. The gold jumped 5x in real terms during this decade (2001-2011).

Presently, the gold prices are only marginally higher than the highs recorded in 2011. Whereas Bitcoin has risen almost 1000% since 2011. Like gold in 2001-2011, Bitcoin has risen 5x since outbreak of Covid19 pandemic, whereas gold is higher by about 5% in this period. The question is whether unconsciously markets are replacing Gold with Bitcoin.

Is Bitcoin replacing Gold

When economics fails in providing solution to a problem of livelihood and sustainability, philosophy always provides the answer.It is a natural instinct of human being to look up to the skies for guidance when all our efforts fail. (Some even do so without making any effort at all!) Religion has therefore been an inextricable part of human life since beginning of the civilization.

Most ancient cultures, China, Egypt, Mesopotamia, Indus Valley etc. have believed in continuation of life after death. Gold being an indestructible (and therefore sacred) object had always been an important part of their religion, culture, traditions and beliefs. It naturally evolved as symbol of power and prestige over time. The church & temples, kings & feudal lords hoarded and displayed gold to asset their power and status.

In past one century, especially past three decades, the factors like popularity and spread of technology in common man's life; rising fascist and communist tendencies due to worsening socio-economic disparities; rise in electronic transactions (personal, social and commercial) thus lower risk (less travel, less physical transactions & deliveries); emergence of new articles of luxury to serve the vanity needs of the affluent; stronger and deeper social security programs; demise of monarchy and feudalism; popularity of spiritualism over rituals; dissipation of church & temples, etc., have all led to sustainable decline in traditional demand and pre-eminence of gold.

In the modern context, technologically challenging things, e.g., Bitcoins, certainly find greater favour with investors as compared to gold.

Conclusion

To conclude, I would say that the ultra-loose monetary policy prevalent in most developed countries shall have to end at some point in time in foreseeable future. This suppression of savers and poor cannot continue into perpetuity. However, ending this tiger ride may not be easy and would require some innovative measures.

For example, the following is one of the scenarios that is potentially possible—

·         US Government and Fed decide to correct the fiscal and monetary indulgences of past couple of decades, by material devaluation of USD and letting USD retire as global reserve currency; settle trade and currency dispute with China agreeing to restore the global trade balance.

·         Global commodities are no longer priced predominantly in USD. The share of neutral currencies (cryptocurrencies) increases substantially in global trade.

·         Consumption pattern change materially. The consumption of fossil fuels, steel, chemicals etc. declines structurally.

·         Digital transformation leads to material rise in productivity, further adding to deflationary pressures created by aging demography of the developed world; thus alleviating the fears of hyperinflation and need to resort to gold as reserve currency.

This may sound fanciful but is not totally unlikely.

There could be many similar or different solutions to end this tiger ride of quantitative easing, negative rates, and suppression of poor (people, economies and regions). Out rightly, rejecting the need and importance an independent currency at this stage could prove to be fatal.

The question, whether Bitcoin would be emerge as the independent global currency would best be answered by time. I would though not reject the probability. Nonetheless, Bitcoin (cryptocurrencies in general) has assumed the status of a popular alternate asset and there is no reason to despise it, just because its price in USD terms is highly volatile presently.