The converse is also true. Thanks to the decline of the dollar relative to Euro, Sterling and the Yen, the real value of our 250+ billion dollars of forex reserves is also undergoing a decline, to the extent they are invested in dollar-denominated assets. The situation is a double-whammy for countries such as India, which have kept their forex assets invested mostly in US Treasury and not diversified, as China, Singapore and Taiwan have done.

The decline of the dollar has evoked much interest in financial circles around the world in recent weeks. This is particularly following the collapse of financial giants, such as Citibank, Merrill Lynch, Bear Stearns, which have taken huge hits on their bottom lines of billions of dollars and seen their CEOs quit, following the sub-prime mess. What is worse, the bankers are unable to say precisely what their losses have been.

The assets in which they have invested their funds have suddenly ceased to have a market since other banks are not keen on financing such insecure assets. The best estimates that the banks make of their distressed assets are only fair estimates. These could deteriorate further.

All this has led to the rest of the world losing confidence in the US financial system’s overall viability. Very truly, this problem, which arose as a result of the US’s sub-prime crisis, may soon become a serious crisis for the millions of global investors who have stuck their necks out, investing in the dollar securities.

The US dollar has declined by 41 per cent against the euro and by 31 per cent against the sterling from its 2002 peak. The decline has been quite sharp ever since the sub-prime based credit crisis unfolded. The decline has been 8.8 per cent since August 2007. This is as of November 11, 2007. The decline continues as crude prices touch the $100-a-barrel mark and food prices soar in the world market.

How does the rest of the world deal with this crisis? How does America itself view the problem? Obviously, US policy-makers view the depreciating dollar with a more kindly eye as it makes their exports competitive and this can lead to more jobs in the US. On the other hand, a depreciating dollar may have inflationary consequences in the US itself, which can offset the export price advantage.

The Federal Reserve may have to look at both sides of the problem. If it finds that the dollar is getting too low, it may see investors deserting US stock markets and this may lead to a further fall of the dollar. It may perhaps have to resort to an interest rate rise in order to attract further investments in US debt instruments. But that will be difficult since the interest rate rise will have recessionary implications for the US and hence for the rest of the world.

As a perceptive review article in Financial Times of November 11, 2007, points out, the rest of the world faces a more serious problem than the US itself. Recalling a famous comment by John B. Connally, the Nixon era US Treasury Secretary, who pointed out, speaking to representatives of other rich countries, that the dollar is the US’s currency but the problem is that of other countries.

It is, however, appropriate to mention that in that period, US policy-makers started arm-twisting countries, such as Germany, Japan and France, to keep their currencies in the right relationships with the dollar. Similarly, a relaxed attitude may not be quite appropriate today when the US depends critically on the rest of the world’s capital inflows to balance its gaping current account deficits running at more than 5-6 per cent of GDP.

It is interesting that the declining US dollar benefits US investors abroad as their investments gain value as the dollar declines. This is the reverse of the problem India faces with an appreciating rupee. Foreign investors gain similarly as the rupee appreciates. US investors abroad gain because their currency declines and foreign investors in the US lose because their investments are denominated in dollars.

The French President, Mr Nicolas Sarkozy, in his recent address to the US Congress, expressed his concern at US complacency about the declining dollar. Such complacency on the part of the US, he pointed out, might lead to monetary disarray in the world at large.

Obviously, the alarm bells have already been rung. The US economy may, however, fall into a recession if the Fed takes counter-measures, such as tightening credit. But what India and other countries that are holding large assets in US dollar-denominated securities have to do is more relevant.

True, a sudden exit of these countries from the dollar may only expedite further decline of the dollar. But, hopefully, in the Indian context, our authorities would have hedged against such catastrophic developments. Obviously, it is time to revisit appropriate alternative strategies for investment, which have a better chance of at least preserving values, if not yielding a decent return.

Memories of India’s encounter with sterling devaluation in the early years of India’s Independence are bound to return. At that time, the amounts involved were relatively small in absolute terms, but the loss was proportionately heavy due to the UK devaluing its currency, in which India’s sterling balance was held.

I do hope that a similar situation does not recur for India. If it happens, the loss to India can be grievous. If the dollar’s recent decline is any guide, our reserves would have suffered a loss of at least 10 per cent in the last three months. 10 per cent of Rs 10 lakh crore of reserves comes to a mind-boggling figure of Rs 1,00,000 crore — a sum India’s economy can ill-afford to lose because of the vagaries of exchange rate policy of the US. Let it not be said that we have not been warned.

The time has come for India to revisit alternative strategies. These include setting up sovereign wealth funds and investing in natural resources and appropriate equity assets. They can also include investment in infrastructure of India. It is relevant to note that the RBI has apparently seen the wisdom of investing its forex reserves in infrastructure in India instead of lending to the US and EU for investing in their infrastructure.

I understand that mechanics are being worked out to make this possible. The investments in India’s infrastructure are at least hedged against any fall in US dollar. It also adds to the economic strength of the country. What use are reserves if they cannot be used to strengthen a country’s real assets?

The recent decline of the dollar may have served a useful purpose if it evokes the appropriate response in our policy-makers. Holding pieces of paper of declining value is not worth the while as much as investing our forex reserves in real assets in the country, if a way can be found to do it. This is one of the lessons that a falling greenback holds for us. Then — and only then — can Connally’s statement be turned on its head. The dollar can be the US’ currency and its own problem, instead of being a problem for every other country!

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