Whenever governments impose regulations aimed at limiting the consumption of goods or services, markets get creative. The black market for illegal drugs is the most obvious example. Along with needless violence, severe resource dislocations are a predictable consequence of prohibition. To circumvent the physical and legal barriers erected by prohibition, criminal enterprises resort to smuggling drugs and other contraband across borders, often using ingenious methods.
I bring up the drug trade to showcase the parallels between the transport of illicit substances and gold. Yes, you heard that right. Ever since India’s government intensified sanctions last August to curb gold imports, the amount of gold being smuggled into the subcontinent has skyrocketed.
In its recently published 2013 annual report, the World Gold Council (WGC) estimates that between 150 and 200 tonnes of gold have been illegally transported into India since the government tightened its stranglehold on gold imports last summer. The spike in the amount of gold being imported into peripheral nations supports the suspicion that smuggling into India is on the rise. As if taking cues from drug cartels, gold smugglers are using very innovative methods to sneak gold into the country. There have even been reports of smugglers swallowing gold nuggets in an attempt to slip past airport security.
India’s love affair with gold is well known. The precious metal holds immense cultural and religious significance for Indians, so you can imagine that the government’s decision to curb gold imports wasn’t easy. However, it was one of the only available options for a country wrestling with a ballooning current account deficit and a weak rupee. In an attempt to alleviate its trade deficit and currency weakness, the government raised the import duty from 8 to 10 percent last summer. Lawmakers also passed a mandate that one-fifth of all gold imports be re-exported since most bullion that enters India is denominated in dollars. This policy has been called the 80:20 rule.
Despite the arguably draconian nature of the sanctions, India’s demand for gold is as robust as ever. The WGC reports that bullion demand in India jumped 13 percent last year to 974.8 tonnes, even though sanctions went into effect mid-year. Based on this official figure, China supplanted India as the world’s largest bullion consumer last year, though keep in mind that as much as 200 tonnes of gold may have entered India illegally.
The inability of the Indian government to stifle domestic gold demand is unsurprising. Even the most powerful and technologically advanced government in the world cannot keep billions of dollars’ worth of illegal drugs from penetrating its borders. In this case, prohibition was destined for failure given gold’s treasured status in Indian society. The metal’s role as an inflation hedge has also arguably never been more important, considering the country’s recent battles with high inflation. It should therefore come as no surprise that the WGC is predicting gold smuggling to stay high as long as these sanctions are in place.
Similarities between illegal drug trafficking and the Indian gold market not only make for great cocktail party conversation, they also illustrate the inelastic nature of India’s gold demand. This is important given that the Eastern world is now the dominant player in the international gold market, particularly when it comes to physical product.
An artificial shortage and double-digit premiums have done little to suppress India’s seemingly insatiable appetite for the yellow, shiny stuff. In response to tight supply, more and more gold scrap is being recycled into jewelry. As this source becomes exhausted, India’s pent-up demand should begin to impact global gold supplies. Eventually, this will be reflected in the international price of gold.
A less obvious inference that can be drawn from India’s situation is the evolving perceptions of gold on the global stage. Simply put, gold’s strong performance early in 2014 is doubly impressive considering that the Indian government has gone to extreme lengths to keep large quantities of gold from crossing its borders.
India’s general elections are right around the corner, and an updated current account deficit figure is scheduled for release later this month; however, all signs indicate that the current sanctions are here to stay for the foreseeable future. In any case, Indian demand is slated to stay fervent for years, if not decades, to come. Should the government ease its grip on gold imports, all that underground demand could easily show up on the London metal’s exchange and push the price of gold even higher. With that being said, the situation in India has demonstrated that the fate of gold is not dependent on a single nation, no matter how influential a particular country may be.
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