Stiglitz Calls for New Reserve Currency

Over the weekend, Nobel laureate Joseph Stiglitz called for a new global reserve currency.

The world economy needs a new global reserve currency to help prevent trade imbalances that are reflected in the national debt of the U.S., said Nobel-prize winning economist Joseph Stiglitz.

A “global system” is needed to replace the dollar as a reserve currency and help avoid a weakening of U.S. credit quality, said Stiglitz, a professor at Columbia University in New York. The dollar fell to an almost 15-month low against the euro last week, and the U.S. trade deficit widened more than forecast in January to the highest level in seven months.

“By taking off the burden of any single country, we don’t have to have trade deficits,” Stiglitz said in an interview in Bretton Woods, New Hampshire. “Things would be much worse if it were not the case that Europe was having even more of a problem, but winning a negative beauty pageant is not the way to create a strong economy.”

Many others have floated this idea and I think it’s a fascinating concept.

The issue is that there’s one currency that the central banks of the world prefer to hold and that’s the U.S. dollar. That’s not much of a surprise since the United States has the world’s largest economy.

There’s debate around the idea that there can only be one reserve currency at a time. The reasoning is that the reserve currency needs to be unique and therefore there can be only one. I’m not sure if that’s theoretically true, but in practice it certainly has been true. The central banks of the world prefer U.S. dollars, though euros play a minor role as well.

But here’s the catch about having the dollar as the world’s reserve currency: there’s an inherent conflict in what the world needs out of it and what the United States needs out of it. We’re not always on the same page. Formally, this is known as the Triffin dilemma in honor the economist Robert Triffin. In fact, the Chinese specifically blamed the Triffin dilemma for the world economy going kablamo in 2008.

In real world concerns, being the world’s reserve currency means that the normal situation for the U.S. is to run a current account deficit. (Of course, one “unnormal” scenario would be a plunging dollar.) The world lets us finance our deficits on the keep and we waste little time in taking advantage of it.

No one has an inherent motive to change the status quo. Until a crisis comes, calling for a new global reserve currency is a futile exercise. The point of a reserve currency is that it doesn’t have to be called for—it’s immediately understood. It’s like telling visitors to Rome that they may want to check out some place called St. Peter’s.

The trend will continue until it stops. I don’t know when that will be, but I know that the end won’t be pleasant.

Edward Harrison has more.

Posted by on April 11th, 2011 at 11:01 am


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