Odd Lots

Raghuram Rajan on Surging Gold and Growing Risks to Financial Stability

October 20, 2025

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  • The surge in gold prices is attributed to a combination of geopolitical risk leading central banks to diversify reserves away from weaponizable currencies, growing distrust in major safe assets like the US Dollar and Treasuries due to fiscal deficits, and the general froth in markets anticipating rate cuts. 
  • Financial crises historically follow a U-shape pattern of monetary policy: a long period of easing followed by tightening, and the current environment, despite recent tightening, shows loose financial conditions (low credit spreads) suggesting vulnerabilities are building. 
  • The BRICS group lacks the cohesive structure to form a meaningful alternative to the US dollar currency system, though they may develop alternative payment systems for diversification, and India's long-term growth potential lies more in services than in fully replacing China's manufacturing base. 

Segments

Gold Surge and Reserve Diversification
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(00:02:45)
  • Key Takeaway: Central banks are moving to gold due to weaponization of payments and lack of trust in developed country currencies.
  • Summary: The demand for gold is driven by central banks seeking assets they control directly, concerns over the safety of developed country currencies given geopolitical risks, and the general uncertainty surrounding safe assets like Japanese debt and Euro area cohesion. Falling interest rates also make holding gold easier, though some price movement is attributed to general market froth.
US Dollar and BRICS Alternatives
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(00:07:17)
  • Key Takeaway: The US dollar remains the global financial system’s basis because there is currently no deep, liquid alternative (TINA factor).
  • Summary: Despite distrust, the US market remains the deepest and most liquid, and the agonizing process around seizing Russian reserves paradoxically suggests the rule of law prevails, albeit slowly. The BRICS entity is not a cohesive structure capable of issuing a common currency, functioning primarily as an anti-West talking place, though developing alternative payment systems is feasible.
Financial Crisis U-Shape Pattern
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(00:11:26)
  • Key Takeaway: Historical financial crises are preceded by a U-shape monetary policy: a long period of easing followed by tightening, with credit expansion during the easy phase determining crisis severity.
  • Summary: The pattern of accommodative policy followed by tightening consistently precedes financial collapse, with greater credit buildup during the easy phase leading to worse outcomes. The recent tightening phase was mitigated by massive public sector support (like PPP), preventing widespread balance sheet damage, but corporate credit continues to grow, creating new vulnerabilities.
AI Boom Investment Risks
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(00:19:02)
  • Key Takeaway: The AI investment boom risks creating malinvestment if the promised productivity gains and revenue realization are significantly delayed relative to infrastructure buildout.
  • Summary: The transition period where infrastructure is built before widespread, profitable use of AI is the critical issue, especially if long-term interest rates remain higher than anticipated. Central banks should caution supervisors regarding lending in this area and factor credit expansion into their rate decisions, as the returns on this investment may prove elusive in the short term.
Political Pressure on Central Banks
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(00:22:53)
  • Key Takeaway: The strength and autonomy of central bank institutions are directly proportional to the political consensus supporting macroeconomic stability.
  • Summary: Developed country institutions are only as strong as the politics supporting them; when consensus breaks down, unorthodox solutions become appealing, threatening central bank independence. Central bankers must possess significant personal backbone to resist political pressure, as structural protections are limited when governments control finances and appointments.
India’s Manufacturing and Services Outlook
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(00:34:33)
  • Key Takeaway: India’s primary growth driver is shifting toward services, where its high-skilled labor arbitrage offers a significant advantage over manufacturing.
  • Summary: India has significantly improved its infrastructure, making it a viable alternative manufacturing center in specific regions, particularly the South and West, which possess educated, disciplined workforces. However, India’s service exports are now on par with manufacturing exports, driven by the global ability to employ highly skilled, lower-cost Indian professionals remotely.
Identifying Future Financial Blowups
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(00:39:48)
  • Key Takeaway: The combination of rising asset prices and increasing credit, particularly in the opaque private credit sector, signals the highest historical risk for a financial blowup.
  • Summary: Leverage is the primary transmission mechanism for financial crises, and while household balance sheets are stronger than in 2008, private credit and low-quality bonds have seen massive increases without traditional covenants. Reports suggest significant bank capital could be wiped out by defaults in private credit, making this area a key source of potential contagion.