Every time my cousin comes visiting to India from the US of A, he always ends of complaining how the cost of living has dramatically gone up since the last time he came to India. Each time he comes, his hopes of relocating to India keeps getting dimmer, as he looks at the spiraling costs and the incomparable standards of living. This is a rather interesting point, US with such high standard of living manages to maintain a significantly low cost of living or inflation. Inspite of subsidy that it gives to farmers and the cheaper than cheap fuel (called gasoline) it offers, the cost of living continues to be low and the standard of living significantly high. Paradoxical!
I present a theory, not mine, but a view point that I endorse to and that has existed for quite some time and dismissed by many as ‘one of the many conspiracy theories’ that does not merit any attention or time. However, a closer scrutiny might indicate that, this theory cannot be dismissed outright. Even if the effects are not deliberate but nonetheless the outcomes are unmistakable. To understand the theory, three facts need to be understood by us:
  • Most countries like to keep their Forex Reserves in the form of Dollars
  • All currencies in the world are equated against the Dollar for it’s value in the market
  • Dollar circulation is entirely managed by an Independent central Bank – Federal Reserve (Fed)  in the US of A.
Fed decides the Monetary Policy independent of the world economic scenario. Whenever USA prints more Dollars and makes money easily available with almost 0% interest rates, the money invariably finds it’s way into the international market via MNCs or FIIs and into other countries as Forex. Two situations arise due to this:
Situation 1
  • More the Dollars in a country = the local currency ‘appreciates’
  • The more the local currency appreciates the more expensive it’s exports become [imports become cheaper]
  • More expensive the exports the less competitive the Country gets in International trade scene
Situation 2
  • Lesser the Dollars in a country than local currency = the local currency ‘depreciates’
  • The more the local currency depreciates the more expensive the imports become [exports become competitive]
  • More expensive the imports the more expensive the Cost of living becomes in the domestic scene
  • More money in circulation also causes domestic inflation
This is the Catch 22 situation of the top order, getting the balance right is not an easy policy decision for any government. Nonetheless an export oriented Developing or Developed Economy can in no way afford to be non-competitive in the International Market, hence invariably the second of the above two options gets chosen. Observe how the price at which US buys products from these countries remains relatively stable helping them keep imports cheap and also by ensuring most of the printed dollars move out of the country they manage to keep a very low inflation. However the Cost of living in the country that is exporting the goods becomes high, due to dearer imports and high amount of local currency in circulation. So in this manner, whether deliberately or unintentionally US exports its inflation by ensuring – There is steady supply of dollars and continuity of international trade in dollars. 

China, the emerging super power and an export oriented developing economy, probably understood this much earlier than others and ensured that their RMB or Chinese Yuan remains rock steady in value verses the Dollar. They tried to keep the value of their currency decoupled from Dollar, so they could continually remain competitive in International Trade and at the same time control prices locally and fuel domestic growth. Ofcourse all of this came at the expense of being called a “Currency Manipulator”, however their objective was met. Other countries with lesser clout than China – do suffer the consequences of Dollar supply. China also has been the most vocal in asking for the International Trade to be done in a neutral currency [Ex: using the SDR of IMF] so the world trade is decoupled from Dollar whose circulation is dictated by Fed entirely based on the domestic requirement in the USA.

So the message I got to give my cousin is, because Cost of Living in India is going up, because US is able to maintain steady or low cost of living and this situation is not expected to change as long as US continues it’s two major exports:
  • Dollars

and hence

  • Inflation