In his keynote address to CSFB's Asian Investment Conference yesterday (March 15), Nobel Prize winning economist, Joseph Stiglitz predicted the demise of the US dollar as the world's reserve currency.
The former World Bank Chief Economist told the audience: "Reserve currencies must serve the role of being a good store of value. The dollar is no longer serving that function and there are alternatives."
Stiglitz said from the perspective of a European, if they had held dollar assets, they would have seen those assets decline in value by 40-50% in terms of their own currency, the euro. "That's the same thing," Stiglitz pointed out, "as if they had seen their purchasing power eroded by 40-50% by inflation. This exchange rate instability is therefore as destructive to a currency's suitability to be a reserve currency as inflation is."
He pointed out that there are now alternative reserve currencies. "There is obviously the euro, and in the future possibly even the Chinese yuan."
Stiglitz said the dollar's right to reserve currency status cannot be taken for granted, and its loss of this status is likely. "We've seen it before with the gold standard and with sterling," he added.
His view on the dollar formed part of an overall pessimism he felt about the US economy. Listing figures for the trillions that would be required for Medicare, the privatization of social security, the war in Iraq and the cost of making Bush's tax cuts permanent, Stiglitz said: "We are looking at a larger and larger fiscal deficit. The hope that it will be cut in half in the next five years is just not borne out by the details. It will be very difficult to make the magnitude of cuts necessary to make that happen."
Stiglitz added that policy decisions were also proving a longer term problem for the US economy. He said investment in science and technology was dropping and thanks to the war on terror the US was no longer benefiting from the influx of talented engineers and students from abroad. He predicted the US's lead in science - "a legacy from immigration after World War Two" - would be lost to China and India.
A major problem he also identified was the fall in the US savings rate from 5.8% of GDP in 2000 to 1.1% in 2004. Responding to a question from the audience that suggested the average American did not realize they were spending beyond their means, he said: "I agree about the seriousness of the problem. Americans are currently benefiting from high housing prices and that makes them confident about spending. It has become a cultural phenomenon and has created a built-in fragility for the economy that makes me pessimistic about the US going forward."
Asked how Americans could be made to save more, he responded: "The sad answer is we don't know how to get Americans to save more - but we do know how to get them to spend more and save less. That was Greenspan's great achievement in 2001."
Currently a professor at Columbia University's economics department, and a member of the Clinton cabinet, Stiglitz said that when the financial markets recognize that political gridlock would not see the deficit reduced, the dollar would weaken. In the worst case scenario, if everyone ran for the exits at the same time, it could lead to a "financial crisis". This was a problem since three times as many dollar securities were held by the private sector as by the world's central banks; and the former would lead the charge for the exits at the same time. "The dollar was attacked in the 1970s and it could happen again."