Editorial 1: Gresham’s law: what happens when governments fix currency exchange rates
Introduction
- Gresham’s law refers to the dictum that “bad money drives out good.” Gresham’s law comes into play when the exchange rate between two moneys or currencies is fixed by the government at a certain ratio that is different from the market exchange rate. Such price fixing causes the undervalued currency — that is, the currency whose price is fixed at a level below the market rate — to go out of circulation. The overvalued currency, on the other hand, remains in circulation but it does not find enough buyers.
Market exchange rate
- It should be noted that the market exchange rate is essentially an equilibrium price at which the supply of a currency is equal to the demand for the currency.
- Also, the supply of a currency in the market rises as its price rises and falls as its price falls; while, on the other hand, the demand for a currency falls as its price rises and rises as its price falls.
- So, when the price of a currency is fixed by the government at a level below the market exchange rate, the currency’s supply drops while demand for the currency rises.
- Thus a price cap can lead to a currency shortage with demand for the currency outpacing supply.
Origins of the term
- Gresham’s law is named after English financier Thomas Gresham who advised the English monarchy on financial matters.
- It applies not just to paper currencies but also to commodity currencies and other goods.
- In fact, whenever the price of any commodity — whether it is used as money or not — is fixed arbitrarily such that it becomes undervalued when compared to the market exchange rate, this causes the commodity to disappear from the formal market.
- The only way to get hold of an undervalued commodity in such cases would be through the black market. Sometimes, countries can even witness the outflow of certain goods through their borders when they are forcibly undervalued by governments.
- Gresham’s law can be seen at play whenever a government fixes the exchange rate (or price) of a commodity money (such as gold and silver coins) far below than the market price of the commodity backing them.
- In such cases, people who hold the commodity money would stop offering the money at the price fixed by the government. They may even melt such commodity money to derive pure gold and silver that they can sell at the market price, which is higher than the rate fixed by the government.
Significance
- Gresham’s law, however, holds true only when the exchange rate between currencies is fixed under law by the government and the law is implemented effectively by authorities.
- In the absence of any government decree fixing the exchange rate between currencies, it is good money that eventually drives bad money out of the market and not the other way round.
- This phenomenon wherein “good money drives out bad” is called Thiers’ law (named after French politician Adolphe Thiers) and it is seen as a complement to Gresham’s law.
- The rise of private cryptocurrencies in recent years has been cited by many analysts as an example of good money issued by private money producers driving out bad money issued by governments.
Conclusion
- When the exchange rate between currencies is not fixed and people have the choice to freely choose between currencies, people gradually stop using currencies that they consider to be of poor quality and adopt currencies that are found to be of better quality.
Editorial 2: Ridding India of food insecurity
Introduction
- India may be the fastest growing large economy of the world, but it is also facing accelerating food-price inflation. The rise in the price of food first accelerated sharply in 2019, and has climbed in most years thereafter. In July this year, annual inflation exceeded 11%, the highest in a decade.
State of Food Security and Nutrition in the World
- The ‘State of Food Security and Nutrition in the World’ of the Food and Agriculture Organization (FAO) estimates the proportion of the population across countries unable to afford a healthy diet.
- The figure for India in 2021 is devastating to note — an estimated 74% of the population cannot afford a healthy diet.
- Given a population of 1,400 million, this makes for approximately one billion Indians.
Finding is plausible
- A study reported found that while the cost of preparing a thaali at home has risen by 65%, in this period, the average wage of a manual worker rose by 38% and that of a salaried worker by 28%.
- The implied reduction in purchasing power is considerable, and it would be reasonable to expect that food consumption has been impacted.
- This would be in line with the reported rise in the prevalence of anaemia, mostly induced by nutrient deficiency, in the latest National Family Health Survey undertaken over 2019-21.
- Over 50% of adult women were estimated to be anaemic. This suggests that the FAO’s finding, that over half of India cannot afford a healthy diet, is plausible.
- Ensuring that Indians have access to a healthy diet is the most important task of economic policy today.
- Macroeconomic policy, relied upon to control inflation, has proved to be useless in the context.
- The Reserve Bank of India has failed in this task, with the inflation rate mostly higher than the target for four years by now. Its approach of contracting output when the inflation rate rises — misleadingly termed “inflation targeting” — does nothing to manage food inflation stemming from the supply side.
- Central banks are incapable of solving this problem, it must be said within any time frame. It is necessary to intervene on the supply side to ensure that food is produced at a steady price by raising the yield on land.
The significance of the Green Revolution
- India has rich experience in this area, having engineered a Green Revolution in the 1960s, but it is not being tapped.
- At the time, reeling under extreme food shortage following two successive droughts, the government orchestrated a supply-side response by providing farmers with high-yielding seeds, cheap credit, and assured prices through procurement.
- This succeeded spectacularly. Within a few years India was no longer dependent on food imports.
- If there was a single event that aided India’s quest to be self-reliant in the highly polarised climate of the Cold War, it was this.
- However, to have engineered the Green Revolution in India at a time when it was a desperately poor country challenged by having to ensure food security to a staggeringly large number is perhaps more significant.
- With hindsight, we can see that mistakes were made, among them the rampant use of chemical fertilizer, fuelled by subsidy, which degraded the soil.
- There was also the reliance on procurement prices rather than productivity increase to ensure farm incomes, which fuelled inflation.
- We also see that the policy was almost exclusively focused on cereals rather than pulses, the main source of protein for most Indians.
- However, rather than carping about the errors made in an extraordinarily successful economic policy intervention, we should be correcting them now.
- At the same time, we should focus on the specific goal of lowering the cost of producing food.
Initiatives to work on
- Expanding on each of these proposals would be in order. It has been pointed out for some time that increased public expenditure on irrigation is not reflected in an increase in irrigated area — whether due to waste or the diversion of funds has not been established.
- The ongoing fragmentation of already small land holdings lowers the capacity for productivity-enhancing capital investment, for which leasing is a solution.
- India’s network of public agricultural research institutes needs to be energised to resume the sterling role they had played in the 1960s.
- Finally, extension has now more or less vanished from where once the gram sevak was a familiar figure in the village, playing a crucial role in the dissemination of best practices. It must be revived.
- These initiatives should be dovetailed into a programme for the manifold increase of protein production, which India is severely deficient in.
- In all the areas identified above, the role of States is crucial.
Conclusion
- It was the Green Revolution that made the first dent on poverty in India. So, the poor did benefit from this strategy. Similarly, now, in order to ensure that all Indians have permanent access to a healthy diet, no approach consistent with ecological security must be off the table.