Economist Stiglitz sees need for global reserve currency system
"The current reserve system is in the process of fraying," the Columbia University economics professor said at a conference in Bankok. "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 Friday weakened about 1 cent against both the euro and the British pound, to $1.4340 and $1.6548, respectively, and weakened about 1 yen to 93.54 against Japan's yen.
The dollar has served as the world's reserve currency for more than 50 years, with institutional investors and foreign governments placing a percentage of their assets in U.S. public debt, such as U.S. Treasuries, and other dollar-denominated assets. This has been largely due to the U.S.'s comparatively low inflation and the dollar's superior performance as a store of value, medium of exchange, and unit of account.
Further, as economist David H. Wang told DailyFinance on Friday, the dollar's reserve currency status also reflects "investors' confidence in the American political system and the inherent fairness of the American people." For example, the United States has never seized assets for monetary or economic reasons, he said. "Never before, in the history of the world, has there been a nation where your assets and reserves are more safe than in the United States," Wang said.
However, Stiglitz cautions that the U.S. government's effort to both stabilize the financial system and jump-start the U.S. economy has led to expenditures of more than $12.8 trillion in monetary stabilization funds and fiscal stimulus. In the process, it has threatened to undermine the dollar's reserve currency status, due to inflation.
"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 Bankok conference. "Right now we're facing deflation, but some time in the future, there will be consequences."
Stiglitz also cautioned that, even if inflation doesn't show up in the U.S. economy in the years ahead, it doesn't mean that price stability will ensue. Inflation could show up in foreign markets, including in Asian property and stock markets.
Monetary Analysis: Stiglitz is decidedly in the camp that the U.S. monetary/fiscal intervention will lead to a substantial decline in the dollar, with higher inflation in other markets, if not in the United States. Certainly from a size of government intervention standpoint, the argument can be made for a weaker buck versus the world's other, major currencies.
Other economists differ on inflation. For example, Stiglitz' counterpart, Princeton University economist, New York Times (NYT) columnist and Nobel Prize winner Paul Krugman argues that the asset destruction caused by the financial crisis and global recession has left the global economy net-short dollars. As Krugman puts it, "It's very hard to have rampant inflation when you're in a liquidity trap." That would tip the scales against rampant inflation.
What stance should investors take when two economic giants differ on inflation/the dollar? The best bet is to await further data. Historically, fiscal stimulus of this magnitude has led to an increase in inflation, but the globalization era offers additional variables that could complicate that theory. A major new factor is the desire of foreign exporters to not increase prices in order to remain competitive in the U.S. and other developed markets. Ultimately, that practice will work to contain inflation.
Bottom Line: It's too soon to conclude to that higher inflation is ahead or to structure one's investments based on that assumption.