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Home > News > Columnists > Subhash Kak

The Dollar's Fall

December 08, 2004

The reaching of the milestone of $125 billion in our foreign exchange reserves was noted with much satisfaction by commentators in India. But what does the effort to increase the reserves mean in the context of the dollar's near free fall over the last couple of years?

The dollar has dropped nearly 40 per cent in value against the euro and over 30 per cent against the Japanese yen. Being the world's de facto international currency, this fall has repercussions for all countries in today's global economy, especially those who own large dollar reserves.

The Bush administration has embraced the weak dollar as a means of getting out of its problems related to its trade deficit that exceeds $500 billion per year. The hope is that as the dollar falls further, American manufacturing would become more competitive. For the Europeans and the Japanese, it would become attractive to establish manufacturing plants in the US, and America will be able to export more of its goods.

The dollar is expected to fall further; the actual amount depending crucially on countries that hold large dollar reserves. The central banks of Asian countries have bought the US dollar to hold down the value of their own currencies. As a result of this, the foreign exchange reserves of these countries have risen by almost a trillion dollars. India's continuing purchase of dollars is also to keep the rupee low in value.

The Organisation for Economic Cooperation and Development last week made its projections for the next year for the world's biggest economies. It sees an average growth of 2.9% for the coming year, which is less than this year's 3.6%. The American budget deficit is forecast to remain above 4% of GDP for the next two years, with the current-account deficit continuing to widen until it reaches about $825 billion in 2006.

Domestic political pressures make it very unlikely that the US will do what is necessary until the situation gets much worse. The US is likely to slow the fall of dollar by raising interest rates. But doing so does not address the underlying structural problems faced by its economy.

The relatively poor countries, in their desire to export more to the United States by competing against each other, are subsidising America. But this process cannot go on indefinitely.

The Chinese reserves are several times that of India, and what it does will decide the speed with which the international drama related to the fall of the dollar unfolds. As it falls further, a large fraction of the true value of the huge reserves of the Chinese will be wiped out. But if they start aggressively exchanging dollars for euros, it will fall even quicker, shrinking their national wealth proportionately faster. The Chinese must do a fine balancing act. They have tried to get away by increasing the pace of investment within the country, but it is leading to serious inflationary pressures within.

The lesson of all this is that globalisation has not made the system very stable. If the post-industrial age is about information, such information value can go through volatile gyrations, as happened at the end of the IT-bubble, and as is likely to happen again as countries jockey for room at the high table while adjusting to America's reduced economic power.

But it is premature to rule America a power in steep decline. It remains the world's most open economy, with superb infrastructure, the best universities, and a tradition of high rewards for innovation and excellence. America is likely to continue as the world leader in intellectual and scientific know-how, although it is possible that it will increasingly become a polarised society, with ever-greater difference between the rich and the poor. The political divide of its red and blue states is a reflection of this polarization.

The rest of the world must eventually shift capital to countries that offer better returns than America. And here China is a much more attractive destination than India, just as it has been for the previous two decades.

China has already cleaned up its major cities by a massive infusion of capital and by rationalising the transport system. The reason why these cities have not been overrun by the poor from the countryside is due to its system of internal passports, so that those who are not already counted as residents of the cities cannot legally reside there. It is the denizens of the rural Second China who constitute the vast army of eager workers happy with wages even less than those of India.

Before it will get into the same league as China's, India will need to make massive investments in pani, sadak, and bijli, not only in the cities but also in the countryside. India's democratic system and our principles foreclose the option of copying the Two China model, but there are other ways to success if we are bold and keep the big picture in mind.

This brings us back to the foreign exchange reserves. I believe, a portion of these should be used for the refurbishing of India's infrastructure. We need water-treatment and sewage plants, investments on sanitation, good housing, and good quality roads beyond the golden quadrilateral project. These investments will create jobs outside of the glamorous high technology sector, and help spread wealth much more evenly.

If we just sit on the money and the dollar keeps on sliding, as all expect it to, not only will we lose more of it in value, we would not have used a great opportunity to transform India.

Subhash Kak

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Number of User Comments: 13

Sub: Genuine leaders wanted, please

What development is possible when those entering and leaving the establishment want to improve their bank balances? Moreover, if infrastructure is built and improved, what ...

Posted by Vijay

Sub: Optimum use of foreign currency reserve.

Nothing much is heard about the infrastructural projects undertaken by the NDA government. Golden quadrilateral project is conspicuous by its absence from today's debate. Congress ...

Posted by Rajendra Shenoy

Sub: Good Analysis

A good Analysis from Kak.Its better we start using over dollar reserves to start developing infrastructure to turn India into a manufacturing hub..thereby giving the ...

Posted by avidnewsreader

Sub: Dollar & FDI

The other day our Finance Minister and Prime Minister were interested in FDI of USD 150 Billions. We have USD 125 billions in reserve.Its beyond ...

Posted by Srinivas

Sub: Well said

Hi I totally agree with u. But the biggest problem everyone knows here is - Who's gonna tell this thing to our rulers ??? Cheers ...

Posted by Yogesh Raut



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