When India exchanged $6.7 billion for 200 metric tons of gold yesterday, the country’s finance minister declared that the U.S. and European economies had “collapsed.” That seems a bit of a stretch.
It is true that the U.S. dollar has weakened and that the Federal Reserve’s decision to maintain the zero interest rate is likely to keep the greenback weak. But has the U.S. economy really collapsed?
Additional evidence from the price of crude oil tends to support India’s view. The recent rise in crude prices also indicate reduced faith in the dollar.
And that’s the primary reason that India decided to buy the IMF’s gold. The country’s foreign exchange reserves total about $285 billion, of which more than 90% was held in foreign currencies, mainly U.S. Treasuries. Less than 4% of India’s reserves were held in gold, and this purchase is expected to increase that percentage to about 6%. India’s government felt they needed to increase their protection against a falling dollar. So the government followed the lead of China, Russia, and Brazil, all of which have increased their gold holdings in recent months.
As the price of crude rises on the weaker dollar, it makes sense for some countries to use gold as a hedge against crude price increases. If gold prices continue to rise to $1,100 per ounce or more, gold reserves can be used to offset higher prices for crude, which are still benchmarked in dollars.
Following this path protects India and the others from the eventuality that the U.S. would decide to inflate its way out of a crude price in the triple digits. There are signs that the dollar is losing its status as the world’s reserve currency, but it will take years for that status to disappear. In the short term, the best India can do is try to hedge its dollar holdings with gold.India’s finance minister is certainly guilty of overstating the weakness in the major western economies. However, the linkage among rising oil prices, rising gold prices, and the weak dollar are real. India, and especially China, cannot afford to watch their assets evaporate if oil gets scarcer and the dollar gets weaker.
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