Stiglitz Sees Risk to Dollar

Need for Reserve System

By Shiyin Chen
Bloomberg, August 21, 2009

The dollar's role as a good store of value is "questionable" and the currency has a high degree of risk, said Nobel Prize–winning economist Joseph Stiglitz.

"There is a need for a global reserve system," Stiglitz, a Columbia University economics professor, said at a conference in Bangkok today. Support from countries like China should ensure orderly discussions on a new reserve system, he added.

The dollar has lost 12 percent since March 5 against an index comprising the euro, yen and four other major currencies. China, the world's largest holder of foreign–currency reserves, and Russia have both called for a new global currency to replace the dollar as the dominant place to store reserves.

"The current reserve system is in the process of fraying," Stiglitz said. "The dollar is not a good store of value. Right now, the dollar is yielding almost no return and yet anybody looking at the dollar has to say there's a high degree of risk."

The dollar will weaken as the U.S. pumps "massive" amounts of money into the economy, according to Curtis A. Mewbourne, a portfolio manager at Pacific Investment Management Co., the world's biggest manager of bond funds.

Still, pessimism over the dollar's prospects may be excessive, with its status as the world's reserve currency still intact, said David Woo, global head of foreign exchange strategy at Barclays Capital in London.

"The reserve currency issue was a big issue three months ago," Woo said in a Bloomberg Television interview yesterday. "But guess what? The dollar hasn't gone anywhere over the last three months for the most part and if anything, we've seen a slowdown in dollar–selling by central banks."

Flood of Liquidity

Policy makers in the U.S. and Europe have flooded the global economy with liquidity, which could lead to speculative bubbles due to limited opportunities for investment, Stiglitz said. The Nobel Prize winner said he was not confident of the Fed's claim that it would withdraw liquidity when needed.

Under Chairman Ben S. Bernanke's stewardship, the Fed cut the benchmark lending rate to as low as zero and expanded credit to the economy by $1.1 trillion over the past year. In the euro region, the European Central Bank has reduced interest rates to a record low of 1 percent.

"As the balance sheet of the Fed has blown up, as the deficit of the U.S. and the debt has increased, people have asked the obvious question: will there be inflation in the future?" Stiglitz told the conference. "Right now we're facing deflation, but some time in the future, there will be consequences."

Asset Bubbles

The liquidity pumped into the U.S. economy may also end up elsewhere, including in Asian property and stocks, Stiglitz said later in Bankgok.

"The liquidity is going to be spent, but not necessarily in America," he said. Asian economies may have to "protect against an American–led asset bubbles."

The global financial crisis also signals the failure of American–style capitalism, Stiglitz told the conference. The worldwide financial system only worked because of repeated government bailouts and markets have been saved from their failures to allocate risk, he said.

Stiglitz said more collective action was needed on a global level to address the crisis and that the Group of 20 has been slow in addressing fundamental problems such as weak aggregate demand. Finance ministers and central bankers from the G20 are due to meet in London on Sept. 4–5.

Early Stages

The global financial crisis, which began with the collapse of the U.S. subprime–lending market in 2007, has led to almost $1.6 trillion of writedowns and credit losses at banks and other financial institutions, according to data compiled by Bloomberg.

Treasury Secretary Timothy Geithner said yesterday the U.S. recovery is still in its early stages, propelled by an improving job market and a housing industry that's beginning to stabilize.

"We have a long way to go, but we are starting to see signs of stability, and these signs mark the first steps to recovery," Geithner said in prepared remarks in Berea, Ohio.

Stiglitz has a more pessimistic view on the U.S. economy, saying that while the worst of the recession may have passed, the likelihood of unemployment in the next one to three years being higher than it had been was "very great."

The economist shared the Nobel Prize in 2001 for work on problems that may arise in markets when parties don't have equal access to information. He was formerly chairman of the White House Council of Economic Advisers under Bill Clinton.

Stiglitz was also the chief economist at the World Bank between 1997 and 2000, during which he clashed with the White House over economic policies it supported at the International Monetary Fund.