By Arshad Shaikh
The Indian rupee is on free fall as it slides toward the psychological threshold mark of ₹100 per US dollar amid rising geopolitical tensions in West Asia. The unjust war by Israel and the US on Iran has caused one of the biggest oil shocks in recent times. Crude oil prices are on the rise with global capital beginning to flow toward safe assets in America, resulting in the strengthening of the US dollar. India imports nearly 85% of its crude oil requirements. Naturally, this puts great pressure on the Indian Rupee because of rising import bills, and spiralling inflation. The Reserve Bank of India (RBI) has stepped in intermittently, selling dollars from its reserves (we still have $690 billion) to prevent excessive volatility.
However, the latest Middle East crisis raises some pertinent questions. Why does every global crisis strengthen the dollar while other currencies like the rupee weaken? Is the current global financial architecture designed to support dollar hegemony? Is there a solution to this system that helps give unprecedented power to the US dollar enabling the American government to leverage that financial monopoly in executing some of its most macabre political projects and military misadventures?
Why the Rupee Keeps Falling
Some argue that the rupee’s depreciation is nothing but a manifestation of the laws of economics and financial logic. It is a well-known fact that during periods of uncertainty, global investors withdraw funds from emerging markets and move them into safer assets such as US Treasury bonds. This creates a surge in demand for US dollars with subsequent downward pressure on currencies like the Indian rupee. This widens India’s current account deficit (CAD) i.e. the import-export deficit; leading to further weakening of the Indian rupee.
There is great debate among economists on how to stem this fall in the currency. Should we permit a free fall or take counter measure to stem its slide? The theoretical argument for a free-floating exchange rate says that allowing the currency rate to be purely decided by the global foreign exchange (forex) market has many benefits. A weaker rupee makes exports more competitive and discourages imports. This helps in correcting trade imbalances. However, for developing economies like India, this argument has some practical limits.
A sharply falling currency fuels inflation. The cost of essential imports will go up. Additionally, it may trigger panic in financial markets as investors start losing confidence in the falling currency. This is why India follows the concept of ‘managed float’, wherein the RBI intervenes in the financial markets to absorb excessive volatility. It is possible for advanced economies to allow their currencies to move freely. But, emerging economies like India cannot afford such luxury. A stable currency is a sine qua non for macroeconomic stability.
Understanding Dollar Hegemony
After the end of the Bretton Woods system (President Nixon ended the dollar’s convertibility to gold), the dollar became the dominant currency in international trade and finance. America insisted that oil be priced in US dollars. This implied that global oil trade would be invoiced in dollars with central banks across the world forced to hold a significant portion of their reserves in dollar-denominated assets. This petrodollar system ensures a constant global demand for the US currency.
The demand for the dollar increases manifold in times of financial turmoil or military conflict. Investors, governments, and global financial institutions rush to buy dollar assets. In some ways, the dollar is not merely a currency but also a bulwark or hedge against financial volatility and instability.
The Triffin Dilemma: America’s Hidden Burden
At a purely academic level, the dollar dominance can also be viewed as a burden for the American economy carrying significant structural costs. Academicians say that the US faces a ‘Triffin dilemma’, borne by any country that holds the global reserve currency.
Dollar hegemony forces the US to feed the financial system with a steady supply of dollars. To do that, the American economy must run persistent trade and fiscal deficits. The total national debt of the United States currently stands at over $39 trillion. The government now spends more than one trillion dollars annually just to pay the interest on its accumulated debt. So more American taxpayer money is spent on interest rather than the welfare programmes of ordinary Americans that they desperately need.
Is Dollar Hegemony Being Challenged?
For many years, there has been a growing resentment in many countries regarding the ‘weaponisation’ of the dollar. The US government has the ability to cripple the economies of its political adversaries (e.g. Iran) through financial sanctions and restrictions on access to the global payment system.
These nations led by China began exploring other options. One such effort is by the BRICS (Brazil, Russia, India, China and South Africa) nations in which they do bilateral trade in local currencies and tell their central banks to accumulate gold for moving away from dollar dependence. China and Russia have reduced their reliance on the dollar in cross-border trade. India has also experimented with rupee-based trade settlements with some countries.
Dollar hegemony still very strong
It would be premature to predict the decline of dollar hegemony. It is an undeniable fact that no other currency today offers the same combination of liquidity, trust, institutional depth, and global acceptance as the US dollar. Dollar dominance is also a result of the American financial markets and its tremendous geopolitical influence (especially over the GCC countries that hold 30% of global proven crude oil reserves and 20% to 22% of global natural gas reserves).
To understand the biggest problem of the dollar hegemony, one must read what American economist, Michael Hudson wrote in his book, The Bubble and Beyond. He says, “Strange as it may seem and irrational as it would be in a more logical system of world diplomacy – the dollar glut is what finances America’s global military build-up. It forces foreign central banks to bear the costs of America’s expanding military empire. The result is a new form of taxation without representation. Keeping international reserves in dollars means recycling dollar inflows to buy US Treasury bills. The US government debt issued largely to finance the military spending that has been a driving force in the US balance-of-payments deficit since the Korean War broke out in 1950.”
It is time for the international community to come together and break this dollar hegemony on the global financial system. Pax Americana has wreaked havoc on the world. It will continue to do so unless we break this cycle of debt bondage and economic coercion.
