In my job, I get to interact with bright minds of the next generation and I am often in awe about how much sharper and well informed each new generation is, compared to the previous ones.
Yet, despite growing intelligence and awareness at an individual level, some core structural pathologies continue to ruin our lives, and most of us are blissfully unaware of this happening. And those who do have some idea of these pathologies, either cynically exploit this pathology for individual benefit, or have no recourse but to watch helplessly seeing their deepest long-term fears come true over a period of 10-20 years.
The thing with structural changes is that they happen gradually, over a long period of time, leading to the parable of the boiled frog where we incrementally adapt every time circumstances change slightly, until it is no longer possible to adapt, and then, there is nowhere else to go.
This post is a short primer about how structural elements of international currency markets affect the destiny of nations, and in turn, over its people. I have been studying and writing about this for more than 25 years now.
One of the primary changes that the new century brought in is that it connected the world like never before-- using Internet, mobile and IoT technologies. A direct result of this is the many fold increase in cross-border transactions as compared to earlier-- a phenomenon called as "globalization".
At that time, globalization was seen as a major, virtuous force that was argued, will break down local hierarchies and create a decentralized world of equals. Terms like "world citizen" were thrown about as a flex.
But fast forward a couple of decades, and we see today, the very places that advocated globalization are now wanting to go back to their conservative past, and put all kinds of restrictions on immigration, and sanctions and tariffs on the rest of the world.
So what exactly is happening? Is it just a pipe-dream to think of a truly global society where the world becomes one, large, happy family? Vasudha eva kutumbakam, and all that?
Globalization has multiple dimensions-- cultural, financial, national, environmental, etc. At an individual level, people largely project the cultural dimension as their rationale for making their choices, but make decisions based mostly on the financial dimension. For instance, one would say that they that they are relocating to a new country in order to "open their minds" and "become a cultural ambassador" or some such corny line, while the primary decision that moves their needle is the amount of money they can make for the same or lesser effort.
But why would someone make more money abroad, than they can in India? Is it because these countries are "developed"? Well maybe (whatever "development" means), but that is just part of the story.
The main structural element that drives international trade today is not so much of demand and supply, but of currency arbitrage. This comes by the disparity between market exchange rates and the exchange rates due to purchasing power parity (PPP) between currencies.
Market exchange rate is the exchange rate determined by the currency exchange markets, based on demand for one currency over another. On the other hand, PPP is the exchange rate based on what a unit of currency can buy in one country over another.
Here is the market and PPP exchange rates between the Indian Rupee and some major world currencies:
Currency
Symbol
Market Rate (INR)
PPP Rate (INR)
US Dollar
USD
92.80
20.34
Euro
EUR
110.32
33.90
British Pound
GBP
126.83
30.36
Chinese Yuan
CNY
13.67
6.18
Japanese Yen
JPY
0.60
0.22
UAE Dirham
AED
25.45
8.96
Swiss Franc
CHF
119.67
22.11
What this means is, on an average what one can buy for $1 in the US, one can buy for Rs. 20 in India. Similarly, what one can buy for 1 Euro in Europe, one can buy for Rs. 33 in India.
However, when we exchange $1 in the currency markets, we get Rs 92, and when we exchange one Euro, we get Rs. 110, more than 300% higher than PPP!
And this is what makes India very cheap whenever someone visits from the US or Europe. The Internet is full of reels that talk about the cheap and affordable healthcare in India, where a blood test costs less than $3, as one YouTube influencer once remarked. Well, the blood test costed Rs. 250, which is not exactly cheap for an average Indian who is living and earning in India.
The following table shows what a salary of INR 1 lakh would translate to different currencies, when compared with PPP and market exchange rates:
Currency
Symbol
Market Rate Salary (What you get)
PPP Equivalent Salary (Lifestyle Match)
US Dollar
USD
$1,077.59
$4,916.42
Euro
EUR
€906.45
€2,949.85
British Pound
GBP
£788.46
£3,293.81
Chinese Yuan
CNY
¥7,315.29
¥16,181.23
Japanese Yen
JPY
¥166,666.67
¥454,545.45
UAE Dirham
AED
3,929.27 AED
11,160.71 AED
Swiss Franc
CHF
835.63 CHF
4,522.84 CHF
For instance, if someone from India were earning Rs. 1 lakhs salary per month, their lifestyle would be comparable to someone earning approximately $5000 in the US. But if the Indian were to visit US, taking their hard-earned savings of INR 1 lakh, they would get approximately about $1000 in exchange, and would be able to afford much lesser than their counterparts earning $5000. Same thing for Europe-- earning in Europe gives 300% more wealth in rupee terms than having to transact with them directly from India.
So where is this extra money coming from, whenever someone exchanges a foreign currency in India? Literally nowhere!
Most money systems today are what are called "fiat" currencies, where money is printed based on the demand for the currency. So more money actually gets minted based on how much demand is there for the currency. So then does this not mean, that we should all be encouraged to live abroad and send more foreign currency back to India, so that the "demand" for Rupee grows?
Not exactly.
For an economy to be healthy, the amount of currency in an economic system need to correspond to the overall "capability" in the system-- which is an abstract term for the ability for value addition, or meeting demand with supply. Economic strength comes from building capability-- capability to conduct business, capability to manufacture, capability to build, capability to learn, capability to serve, etc.
When we have too little money supply compared to the capability in the system, the economy undergoes a deflation, where despite existing capabilities, economic transactions cannot happen due to a dearth of currency. This is also called an "economic hole"-- a condition where capability exists, but money doesn't exist.
On the other hand, if the money supply is more than the available capability of the system, we encounter a "hyperinflation" where the available money cannot get converted into value.
I'm reminded of a movie where a group of soldiers who are lost in Amazonian jungles come across a crashed airplane that has was transporting a couple of million dollars. They are all very excited to find this huge stash of money and each one grabs whatever they can. But then, in that small "economy" that they have, they are unable to exchange it for any value. As a result, when one of the soldiers who has cigarettes with him, "sells" it to the others at $1000 a piece! The other one who has a matchbox sells each matchstick for $2000 since he knows that everyone who bought a cigarette will need a matchstick!
Just blindly bringing in more foreign currency into the system will eventually result in an economy that has gone bonkers!
(Our economy has already gone bonkers to quite an extent. Just look at the state of basic things like public infrastructure in a city like Bangalore that boasts of being the world's third biggest tech cluster. I remember when the roads in front of our house were left dug up for more than 2 years, and we used to get Whatsapp forwards to "feel proud" because India is now building high-speed trains for Australia or some such! We think we have the capability-- but we don't. We just build technology that has already been conceptualized and designed by others. When we are asked to dream big and create startups-- we only think in terms of food delivery apps, ice cream stores, etc.).
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So why then is the market exchange rate so different from PPP?
The answer is not economics, but geopolitics.
Fiat currencies today are ideally supposed to print currency based on the available capability of their economy. But they print currency based on the demand for the currency. Both are not the same.
Today, a large part of currency demand comes from the geopolitics of which currency is used by countries to trade among themselves. Most petroleum trade for example, needs to happen in US dollars. Hence, if country A has petroleum deposits, and country B has money to pay for it-- country B will first need to buy US dollars from their money, and then buy the oil from country A.
And how is this enforced? Through sanctions, trade, diplomatic manipulations, and even military action! In that sense, whenever we pay Rs 94 for a dollar when its purchasing power parity is at Rs. 20, we are paying Rs 74 for the geopolitics of sanctions and military actions.
If a country becomes largely dependent on foreign currency inflows for running its economy, it has basically compromised its sovereignty to external forces. This video about the sovereign debt of the US, and the sovereign debt of other countries dependent on the US dollar provides a lot of clarity:
So at an individual level, what can we do to ensure that we are not contributing to this slow game that creates dependencies between nations?
The principles are simple, really. Go abroad if you must, to obtain skills, knowledge and exposure. But come back when time is still on your side, and contribute to the economy by just living in the country (put your skin in the game). Work honestly and smartly in whatever you are good at, to add value. Invest smartly and strategically in the country. Participate by voting in elections, and by contributing your expertise where needed. Innovate to help reduce dependency of the country on external resources. Exercise vigilance to keep at least your surroundings safe.
