Uncle Sam's Dollar Ponzi Scheme

US's terrible political and economic leadership will ultimately cost the dollar its value.
India must act early to avoid being dragged down, suggests R Jagannathan.

The Narendra Modi government has set a target of making India a $5 trillion economy in the next two years and the third-largest economy before 2029.

The problem is not with these aspirational goals, but with targeting them through a measurement metric that you cannot control -- the dollar-rupee exchange rate.

In theory, you can hit your $5 trillion target even earlier if the rupee strengthens; you can miss the target if the reverse happens.

Over the medium to long term, a dollar decline is more likely than a strengthening, thanks to two major follies embraced by a reckless US government (including the US Federal Reserve Board) after the global financial crisis (GFC) of 2008.

The solution to the GFC, and later Covid, was endless money printing and near-zero-cost money. And after the Ukraine war broke out, the US chose to 'punish' Russia by confiscating its massive dollar reserves.

Ever since, China -- and more recently India -- have been trying to buy more gold to reduce their dependence on dollar reserves.

In April, China's holdings of US Treasury stocks were less than a quarter of its total reserves of $3.2 trillion, and it has been buying gold every single month for the last year and a half.

India bought 24 tonnes of gold in January-April this year, more than the 16 tonnes bought in 2023.

The move away from the dollar now has two legs: A deteriorating US fiscal situation and a general loss of trust in Uncle Sam's willingness to honour the rules underpinning global financial stocks and flows.

For India, this implies that we must increase our gold holdings from 8.7 per cent of reserves to closer to 12 to 15 per cent -- in stages.

It also means we must be mentally open to any de-dollarisation initiative from anywhere, including Brics.

A new book, by Shanmuganathan N (Shan for short), titled RIP USD (1971-202X), suggests that this impending demise of the dollar may happen in this decade, though one cannot bet on it.

While one can assume that ultimately the markets will opt out of the dollar Ponzi game, inertia and short-term self-interest will ensure that the actual collapse date cannot be predicted with certainty.

Shan is a votary of free markets, as advocated by the Austrian School of economics. He says that 'no fiat currency has ever survived more than a few decades' and forecasts that the purchasing power of the US dollar will collapse, leading not only to a depression, but a depression accompanied by high inflation (unlike the Great Depression, which saw deflation).

The author believes that any solution that is not backed by some form of gold will not help the US dollar.

The US went off its own limited gold standard in 1971, when Richard Nixon announced that the dollar will not be linked to gold at $35 an ounce.

At the current price of $2,328 an ounce, gold has appreciated 66-fold against the greenback since 1971.

For India's part, we must do everything to steadily de-dollarise our thoughts and actions, though in the foreseeable future, there may be no alternative (TINA).

The dollar has defied gravity for one, and only one, reason: It is still the only acceptable safe haven currency and most used for settling international transactions.

Neither the euro, nor the Chinese yuan, have managed to fill that need, the former because of the mindless expansion of the eurozone without adequate fiscal restraints (among other things), and the latter because China has shown itself to be an aggressive bully that can't be fully trusted.

According to Shan, the most likely scenario that will challenge the dollar's hegemony will be the creation of a gold-backed reserve currency by a group of nations.

He does not think that cryptocurrencies will do what gold can do, since crypto has no use-value unlike gold.

Logically, this is what any Brics initiative ought to do, but the mistrust in India-China relations after China's unilateral decision to scrap border stability in 2020 has ensured that Asia's two largest economies (ex-Japan) will be in no hurry to create a gold-backed global currency.

In the wake of the Ukraine war, Europe has become too dependent on the US for security to break away on the monetary front. The dollar reigns because the rest of the world can't get its act together.

That situation may not last forever. One has to assume that macroeconomics will bring the US dollar down before shifting geopolitical trends aid that decline.

US national debt has skyrocketed from 7.8 per cent of gross domestic product (GDP) in 1971 to 120 per cent in 2023. The US has been creating $2 trillion of additional debt every year for the past few years.

The jokers in the pack could well be private individuals and entities who hold dollars.

The US Fed estimated in 2021 that nearly 45 per cent of cash dollars (two-thirds of it in $100 notes) are held abroad.

Not just governments, but individuals and criminal cartels hold the dollar due to its wide acceptability.

The future behaviour of these private holders of greenback is difficult to predict, since they too have the option of shifting partially from dollar to crypto-currency or physical assets like real estate and gold.

The point for India to note is this: While the dollar may continue its high perch in the foreseeable future, our national goals should be set in real rupee terms, which is what we can control through our own macroeconomic policies.

It is far better to say that we will double real GDP in 10 years to Rs 350 trillion by maintaining 7 per cent real average growth rather than saying we will be a $10 trillion economy by the early 2030s.

We need to be rupee-focused in our aspirational targets too. We must de-dollarise our thinking.

Disclaimer: These are R Jagannathan's personal views.

Feature Presentation: Rajesh Alva/Rediff.com