Saturday, October 3, 2015

RBI Governor Rajan is Lying

Last Tuesday the central bank of India, RBI, announced its much awaited last quarter monetary policy. The present governor of RBI Dr. Raghuram Rajan was under tremendous pressure of his Delhi masters to reduce the interest rates. Not disappointing his masters, he reduced the repo rate by a big 50 basis point. Raghuram Rajan has an image of an "inflation warrior"; a "monetary-policy hawk"! He is quite famous for his so-called "anti-inflation stance". People think that he was at loggerheads with his Delhi masters, especially the finance minister Arun Jaitley. Many well-known international investors have praised his stubbornness to reduce the interest rate; many even thought of nominating him for a "Nobel Prize" in economic science (it is a different matter that there is no Nobel Prize in economic science; the present prize is given by the Swedish Central Bank in the memory of Alfred Nobel!).

So, is Raghuram Rajan an "inflation warrior" or is he "inflation creator"? Is he really at loggerheads with his Delhi masters or he is complying with them whenever they demand him to? The key to answer all these questions and to understand Raghuram Rajan is to observe his actions, and not his words. Listening to his speeches will make one feel as if Rajan is seriously worried about inflation, but when we look at his action we see something very different. Remember, at the end of the day, it doesn't matter what you say, but it matters what you do.

Is he inflation warrior or creator? 

To understand this answer we must first clearly understand what inflation is. Today's mainstream economists define inflation as a "rise in the general price level". Is this definition correct? Inflation, traditionally, was never defined in this way. Prior to 1980s the true definition of inflation always was a "rise in the supply of money and credit" e.g., read this Wall Street Journal article showing the evolution of definition of inflation. Why did the mainstream economists change the definition? Because they wanted to divert gullible publics' attention from the real cause of inflation, which is the rise in the supply of money and credit, to its effects, one of which is rising prices! Once you change your focus from the real cause of inflation to its effects, it is easy to blame everyone else but the real culprit who is creating inflation. In today's time the central bank - in India RBI - is the monetary central planning institution which has a monopoly over printing rupees. That means, it is the RBI which is solely responsible for creating inflation in the Indian economy. Rising prices is just one of the chief effects of inflation; it itself is not an inflation (please read this one page article on inflation by Henry Hazlitt to understand this phenomena).  

Once clarifying the definition of inflation now we can see that Raghuram Rajan is no "inflation warrior". He, in fact, is the main guy who is creating inflation in the Indian economy just like his predecessor governors. Since assuming the governorship of RBI in September 2013, Rajan has decreased interest rates from peak 8% in January 2014 to 6.75% today (data here)! That is a big cut of 1.25 basis point. RBI reduces interest rates by increasing the money supply in the economy, and that is what IS inflation. The commercial banks will now pyramid their own money supply on this base money provided by RBI and inflate the currency more (to understand the mystery of banking please read Rothbard's brilliant book, The Mystery of Banking). So, Rajan is the one who is creating all the inflation that we see in the Indian economy. To think that he is an "inflation warrior" is a mockery of economic science.

And these continuous reductions in last one an half years' time also shows that Rajan is not at all at loggerheads with his master Delhi government. Whenever they demanded an interest rate cut, he has sooner or later followed their orders notwithstanding his rhetorics against inflation.

This is not everything about Raghuram Rajan. During the recent rate cut press interviews he said few things which will outrage most sane people. In an interview with newspaper The Hindu, Rajan said that, Common man is always benefited by a rate cut. Really? How so? His twisted logic, and I quote, is this:
I think bringing down inflation is the most proper move we have done. Once inflation comes down, keeping rates at a very high level increases the cost for the entire economy. I receive letters periodically from pensioners who say they used to get 10 per cent on their deposits, but now they are getting only eight per cent. However, they don’t realise that they got 10 per cent when the inflation was 11 per cent. Even though they got 10 per cent returns their principal was eroded by a greater amount every year. So, real value of savings were going down. 
Today, if they are getting 8 per cent with inflation at 6 or 5.5 per cent they getting a real return of 2.5 per cent, which is compensating the erosion of their principal so real returns have gone up.
On the surface this arguments looks plausible, but to see why Rajan is wrong we have to only see how the government statisticians measure inflation. Government inflation numbers are based on wholesale prices where prices are always lower than the retail market. Not only that, they only include selected goods in their inflation basket, and the selection of these goods is arbitrary depending on the whims of government politicians and bureaucrats. The highly aggregate macroeconomic inflation numbers hide all the differences in the life styles of individuals in this country. The inflation numbers may go down on government and RBI records, but in ground reality the prices never come down; in fact, they keep on rising year over year e.g., I have never seen prices of most products that I consume go down like many common men of this country (see here). The whole exercise of measuring inflation by taking prices of selected goods in consideration is dubious. It doesn't reflect the ground reality of how people are living and facing real prices rises in their day to day life. Rajan's above arguments are totally disconnected from the ground reality. He is living in his ivory tower with his dubious official numbers. He forgot what the famous phrase about the use of statistics, which is falsely attributed to the British Prime Minister Benjamin Disraeli, says: "There are three kinds of lies: lies, damned lies, and statistics." Rajan is just fooling the pensioners and other hard working saving public of this country with his misleading false arguments. He is not realizing that millions of poor people of this country, who earn their daily bread, never receive any pension! They don't even have any bank account where they get any interest. Their wages are

Above all, as I said above, inflation is not rising prices! It is the increase in the supply of money and credit for which Rajan himself is responsible. Rising prices is only one of the chief effects of inflation. Rising prices definitely do not benefit the common man, but the worst part of inflation is its other effects in the forms of the business cycles and the rising inequality of income where poor gets poor and rich, richer. The manipulation of interest rate results into boom-bust cycle in the economy which hurts the whole economic structure and thus every one of us. The distribution of money by RBI to its favored unproductive debtor class hurts the productive creditors (i.e., savers) of the economy.


So RBI's rate cut policy can never help common men. Rajan is outright lying when he said that. Rajan is not an "inflation warrior". He is the prime creator of inflation in India. Only dismantling RBI and bring the Gold standard back, we can think of doing anything good for the common men of this country.