Today, most of the developing countries (as in Asia) are reliant on exports to increase their GDP and thereby their standard of living. And for their exports to be competitive they ensure that their national currencies are weaker as compared to the industrialized countries to which they export. Hence the Chinese Yuan is artificially pegged low against the Dollar and the Euro to ensure Chinese Exports remain competitive. Similarly Indian central bank buys dollar when it senses the rupee strengthening against the dollar.
Currency is a contract by a country’s government (monitored by the central bank) to honor paper against gold. However after 1914 and subsequently in 1933 and 1971, world government’s have dishonored this contract and taken back gold from the bullion banks (Central banks hold gold which should be redeemable against paper-currency held by the citizens. This gold is then leased to Bullion banks in lieu of an interest payment. Bullion banks then typically sell off this gold to invest in other securities. In the event that there is a run on gold, then neither the bullion banks nor the central banks can honor the paper-currency). Currently, currencies around the world are not pegged to the gold which means that there could be 100 rupees in circulation but to back this Rs. 100 only Rs. 10 of Gold could be in the RBI reserves.
How does this current devaluation affect the world economy and more specifically the Asian Economies? You must be aware that the US Annual Trade Deficit is approximately $500 Billion. Today most Asian economies have huge reserves of dollar and Euro denominated currency/securities which mean that they are funding the Total US deficit of $1.75 trillion. And you may ask who possesses these foreign currency reserves? As per a World Bank report, the developing Countries have $2.95 Trillion as opposed to $1.5 Trillion with Industrialized countries. The breakup of the amount present with the Developing countries is as follows
Dollars = 1.75 Trillion
Euros = 0.80 Trillion
Others = 0.40 Trillion
Now that we know of the total currency reserves, let’s move onto the actual commodity that is supposed to be backing the currency…GOLD!
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