Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

The political economy of selling gold reserves

For those of us in India who lived through the economic crisis of 1991, one of the images seared into our memory is that of the plane taking off from Mumbai to London filled with gold to be pledged for an emergency loan. This helped create a broad consensus among politicians and bureaucrats to do whatever it takes to solve the crisis and bring back the gold. Almost two decades later, that episode still influences the thinking of policymakers. I believe that it played some role in the government’s decision last year to buy some gold in the IMF gold auction.

Similarly, one of the enduring images of the Asian crisis of 1997 is that of Korean citizens depositing their gold with the government so that the country could pledge this gold for badly needed loans. The Korean people took ownership of the problem and became determined to overcome the crisis.

I was reminded of all this when I read an article in Time (originally published in Die Welt) pointing out that both Greece and Portugal are sitting on billions of dollars of gold reserves even while they are being bailed out by the EU and the IMF.

It appears to me that when countries receive help before they have exhausted their own resources, the moral hazard is exacerbated. Moreover, commitment to painful reforms is likely to be very weak. During the Asian crisis, the IMF was accused of being too harsh. The reality is that while the IMF medicine was bitter (in a few cases, unnecessarily so), it was successful in creating dynamic economies that could put the crisis behind them.

Responding to the criticism that it was subjected to after the Asian crisis, the IMF seems to have turned from a purveyor of bitter medicine to a dispenser of sugar coated placebos. The EU is even less willing to take any harsh action. This is most unfortunate, and I believe years from now, peripheral Europe would wish that they had a sterner taskmaster.


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