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Saturday, April 09, 2011

US Dollar, Indian Rupee and Gold

You would have come across an article or two saying everything is wrong with US Dollars, unless you were hiding in a cave.  I am trying to look at what could be wrong, fundamentally.

Indian Rupee
Reserve Bank of India has in circulation Rs.8,420,409,791,000 worth of notes (8.420 trillion or 8.420 Lakh Crores).  There is Rs. 485,772,152,000 (0.485 Trillion or 485 Thousand Crore) worth of gold against it.  That is about 5% of Rupee in circulation is backed by gold and all of the gold is held in India. 
1. It means that about 95% of the currency backing is foreign securities.  So, if you are holding a Rs. 1000 note in your hand - Rs.50 worth of that is in gold and Rs.950 is in foreign securities. 
2. It also means that notes in circulation is about Rs.8,000 per Indian vs. per capita income of about Rs. 44,000.  Considering that Rupee doesn't move much outside the border, it gives you a rough idea of how fast the currency changes hands.

Now let us talk about the 950 of the 1000.  RBI is permitted to hold such securities in the currency of any IMF member country or in securities issued by IMF, World Bank or BIS.  Here's the key condition - the maturity of these cannot be beyond a period of 10 years.  Also, the Gold in the 50 of the 1000 - 85% of that should be held in India.

Now, here's another factoid.  About 60+% of world currency reserves are held in USD.  So if we assume that 2/3rds of the Rupee is USD since it is backed by foreign securities, we have about Rs. 670 of that Rs. 1,000 is USD.  So, when you are holding that Rs.1,000 note, you are actually holding about USD 15 plus about 1/40th of a gram of Gold and the rest in others.  (That should be enough to pause before you spend, to think of what you are exchanging really.)

I admit that the reserves are actively managed by RBI by people who think about this risk and nothing else.  Still, if want to achieve just a 50% cover in Gold, it would mean about 10,000 years of 200 tonne lot of Gold buying or Gold price appreciating that many times.  Both look like wishful thinking.  US Dollar, therefore, is a cause for concern to us even if we are earning and investing in India. So, if USD is worthless,  around 70% of INR is worthless.
(Source for data: Reserve Bank of India)
US Dollars
Compare this scenario against US Dollars (Feb 2011) - 
Currency - 928.7 Billion
Reserve Assets - 134.7 Billion.
Value of reserve Assets hide a very important picture - Gold stock valued at 11 Billion is valued at $42.22 per Troy Ounce.  The value of gold in the market per troy ounce in Feb. was between $1,340 and $1,440.  Revaluing gold would add another 350 Billion to the reserves.   Still we have 485 Billion Vs 929 Billion of currency issued.  To achieve parity, Gold would have to go up double from this (no, I am not making a prediction).
(Source for data: Federal Reserve and Kitco for gold prices)

Look at it this way, every time USD loses value, INR loses about 70% of that in relation.  Now, this is only a comparison of two currencies - against their reserves.  Now, if you take into account interest rate parity adjusted for inflation, growth trajectory of two economies and keeping in mind everything in the forex market moves relative to one another, you can draw your own conclusions on where we are headed.

How is it all relevant?  At the end of the day, when you invest in India everything is denominated in Rupees and settled in Rupees.  This is an attempt to get to the bottom of that Rupee.
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