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Mercantilist view on gold and growth in current stance for profitability!

, January 7, 2014, 0 Comments

Mercantilist (Seventeenth Century) believed the more the gold and silver reserves; the better it was for the nation. The wealth of nations was measured by the greater accumulation of precious metals as per Mercantilists. However, in today’s context, how much the Foreign Exchange Reserves actually build up depends on the Current Account Balance Situation in nations. Linking it to the Economic Situations and Balance of Payment Account, the more the exports to the imports, the more the Current Account Surplus. If there is a Current Account Surplus situation in the economy, then the foreign funds accrue in the nation in the form of greater exports revenue. Since the balance of payments account is always in balance, with the foreign funds coming in, financial assets can be acquired abroad by the nation as well the foreign exchange reserves can be build up. The Foreign Exchange Reserves can be used to finance imports.

Taking another situation, when there is Current Account Deficit in a nation, implying imports greater than exports, the selling of existent financial assets and running down of foreign exchange reserves is done to finance the imports. The understanding of Balance of Payments Account or the account that records the External Account Transactions of a nation with the rest of the world actually sets the guidelines of the build up of Foreign Exchange Reserves for any Nation and emphasize on the move towards a higher growth trajectory as per the Mercantilist view on Gold.

Eventually, the entire situation of the Foreign Exchange Reserves, gold and bullion accumulation depends on the Current Account Gap. Also based on the reserves of Gold etc Money is printed. The back-up of printed Money are the reserves of gold and assets. So indirectly the Money Supply in the Economy is also linked to the Mercantilist View on the Asset.

When a country starts buying more of gold, bullion to build up its Foreign Exchange Reserves, with the greater demand of gold by the Central Bank, the price of Gold rises too. But as gold is majorly imported in India, to put a curb on it’s further rising demand and price rise, import duties are raised on it. By this way, its price is checked by the government intervention and subsequent market mechanism correction.

Foreign Exchange Reserves include SDR, Gold and Assets in Foreign Currency. For seeing the impact in the data of a possible increase or decrease in Foreign Exchange Reserves minus the Exchange Rate volatility, the Foreign Exchange Reserves data is in US Dollars.

Linking Data on GDP, Money Supply, Foreign Exchange Reserves and Current Account of Balance of Payments, the following trend pattern is observed.

Mercantilist view on gold and growth - MarketExpress

As Current Account Deficit of India deteriorated from 2007-08 to 2008-09,the Foreign Exchange Reserves also got depleted in US Million Dollars. When there was a steady phase of Current Account Balance from 2008-09 to 2010-11, the Foreign Exchange Reserves also improvised. With a further deterioration in Current Account Deficit in 2010-11 to 2011-12,the Reserves further plummeted.

Linking it with the GDP growth rates in the same period, beginning with 2007-08,when the GDP Growth Rates were high (owing to comparatively lower CAD and higher Foreign Exchange Reserves accumulation) to a dip in Growth rates in the period 2008-09 which was followed by a drop in Foreign Exchange Reserves and a higher CAD to a rise in the Growth  Rates further in the steady phase of stable CAD and Foreign Exchange Reserves Build–up. In 2011-12 also, the data points to the logic of lower growth accompanied by a higher CAD and lower Foreign Exchange Reserves.

Rate of growth of gdp - MarketExpress

Thus, what can be concluded is the fact that the Classical Economists Mercantilist View of greater Accumulation of Gold etc as  better for the nation  still holds true. Higher  Foreign Exchange Reserves including Gold are accompanied by lower Current Account Deficit figures and better  Growth Rates. So, when the Current Account Figures fall for a nation, the build up towards a trajectory of higher growth, more purchase of Gold and Foreign Exchange Reserves and subsequently a rise in the price of Gold can be expected.

The same sequence can be applied for better profits in the Derivatives Market with the slightest of hint of fall in CAD figures!