The global economic landscape is undergoing a significant transformation, marked by shifts in power dynamics, growing inequalities, and the intricate dance of international currencies. This article, drawing insights from a recent “Growing India Podcast” featuring economist Neelkanth Mishra, explores the multifaceted challenges facing the US economy and highlights India’s emerging role amidst these changes.
The Real Problems Behind Trade Wars
The current wave of trade wars, often attributed to figures like President Donald Trump, are not arbitrary actions but rather “bad attempted solutions” to “very real” underlying problems. These issues, festering for a while, have manifested in a complex global environment.
Firstly, there’s a need for a “reset” in global cooperation as the center of economic gravity shifts from a unipolar world dominated by the US in 1945 to a more multipolar one. The existing international structures, largely designed post-World War II, struggle to accommodate the rise of new economic powers like China, India, and Brazil. Historical precedents suggest that such periods often culminate in major realignments, with past systems, like the League of Nations, failing to prevent subsequent conflicts.
Secondly, significant inequality within the US itself contributes to the political unrest. The life expectancy gap between white male graduates and non-graduates has widened, and the median quality of life for nearly half the US population has remained stagnant for the past 35 years, fueling discontent and impacting political discourse.
Thirdly, national security concerns are driving a desire for increased domestic manufacturing capacity in the US. This is rooted in fears of a “hot war” and the recognition that the ability to rapidly produce essential goods, as seen in World War II, is crucial.
The Dollar’s Predicament: A Myth on the Brink?
Perhaps the most directly impactful issue is the status of the US dollar as the global reserve currency. While a single dominant currency aids global efficiency by narrowing exchange rate spreads , the dollar’s current position is unsustainable. Mishra describes currency as a “myth”, whose value is intrinsically tied to the issuer’s credibility and discipline. The US, in the last 20-25 years, has been “massively indisciplined with their fiscal math,” leading to net liabilities of $28 trillion, making the current dollar valuation unsustainable.
A reset in the dollar’s value, with a fall of “25-30% at least,” is necessary. The trade-weighted dollar is currently at levels last seen in 1971 and 1985, periods followed by substantial devaluations. However, devaluing the dollar is far more complex now than in previous decades when the US could “negotiate” with economically dependent Western Europe and Japan. A multilateral agreement for devaluation is “very difficult” as other countries, especially China, would be reluctant to see their currencies appreciate against the dollar for fear of hurting their own manufacturing sectors.
Trump’s administration’s approach of bilateral deals, while effective against smaller economies like India and Vietnam, struggles with the multilateral nature of currency devaluation. Potential tools like a withholding tax on US Treasuries could devalue the dollar by reducing demand, but such “costless solutions” do not exist and would raise the cost of capital in the US.
Ultimately, market forces will likely drive the dollar’s devaluation. The increasing volatility of the dollar makes hedging more expensive, making US assets less attractive for foreign investors, which in turn puts downward pressure on the dollar. Significant currency market turbulence is expected in the next three to five years. The alternative, if market forces don’t work, could be an increased risk of war.
China’s Economic Headwinds and the Risk of Conflict
China, too, faces “deep economic trouble”. Its economic model, heavily reliant on real estate and urban infrastructure development, is “no longer working”. While a segment of the population thrives, the majority struggles to participate. The shift in bank lending towards industry has created overcapacity, both domestically and globally, making it difficult for companies to profit and export. If exports falter, leading to economic weakness and political turbulence, there’s a heightened “temptation to distract the masses through a war”. Resolving these economic imbalances quickly, within the next year or two, is crucial to prevent “outcomes that can really deter”.
India’s Opportunity: A Third Winner?
Amidst these global power struggles, India stands to be a “quite smaller third winner”. While not necessarily in terms of global ranking, India’s winning is contextual to its own development. The country has successfully managed its fiscal deficit, and the “fiscal squeeze is over”. Despite an 80% debt-to-GDP ratio, most of it is held domestically, placing India in a “very good place on the macro”.
India’s strength lies in its domestic demand, which drives investment. Unlike economies that rely on government-driven initiatives, Indian entrepreneurs will set up factories when they perceive genuine demand. The current global scenario, with the US and China appearing “tired and panting” after their economic “marathons,” positions India as a fresh contender with significant growth potential.
The Dedollarization Debate and the Role of Gold
The concept of dedollarization, a shift away from the dollar as the primary international medium of exchange, is unlikely to happen rapidly. There’s currently “no where to go” for an alternative. While gold might seem like a contender, there isn’t enough gold in the world to back the total monetary value of existing currencies. Stablecoins, essentially digital money market mutual funds, are also not a true alternative as they are typically backed by existing currencies, often the dollar. Central Bank Digital Currencies (CBDCs) are emerging, but their success remains limited.
The dollar’s deep entrenchment in the global financial and trade ecosystem, built over a century, is a powerful “network effect” that makes displacement very difficult without major upheaval. However, as India’s share of world GDP and trade grows, the rupee could slowly gain more prominence in international invoicing.
Ultimately, the global economy faces a complex future with significant uncertainty, particularly in currency markets. Resolving these deep-seated issues will require a “struggle”, but the consequences of inaction could be dire.
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