Global reserve could prevent future calamity

A global reserve system should be created to allow countries to spend more money in a productive and efficient way, instead of accumulating reserves for use in a possible financial crisis, Nobel Prize-winning economist Joseph Stiglitz, a former senior vice president and chief economist of the World Bank, said in a recent interview with The Asahi Shimbun in Tokyo.

He embraces the proposed creation of a European version of the International Monetary Fund as a way to stabilize the euro, while advocating the need for Asian nations to step up their regional cooperation for currency stability.

Regarding the state of the Japanese economy, the Columbia University professor said that monetary authorities should guide the yen's value to a lower level, even resorting to market intervention if necessary, to help Japanese businesses become more internationally competitive.

Following are excerpts from the interview:

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Question: Earlier today (March 17) you asserted in your remarks at a panel discussion at the Asian Development Bank Institute in Tokyo that the world needs a new financial reserve system. Your point is that countries are accumulating excessive reserves, weakening global demand.

At the same time, you assert in your new book "Freefall" that, following the global economic crisis, a new capitalist system should be created which would strike a proper balance between the role of governments and the role of markets. How does the proposed new reserve system fit in with this new capitalist system?

Answer: Let me step back a second. I began by pointing out that, unlike when the flexible exchange rate system was created after the collapse of the Bretton Woods system (the international monetary regime that prevailed from the end of World War II until the early 1970s), there was the hope among people like (economist Milton) Friedman, that markets would be self-regulating. Markets would provide insurance, manage risk, do all those things. They failed.

And we saw that, actually, continuously, but the (global economic) crisis is sort of the culmination of almost four-decades of instability, of evidence that markets are not self-regulating. So there's a need for government.

Then the question is: What are the institutional frameworks for regulating the volatility of the economy? Within a country we have created monetary policy and fiscal policy as the two key macro-regulators. We don't have anything internationally corresponding (to that). And so this is an attempt to partially fill in the gap on the monetary and financial side. The current system has a built-in deflationary bias, a built-in bias toward instability, and this (new reserve) system could partially alleviate both of those problems.

Q: I understand your point that a deflationary structure is due to the fact that different nations accumulate currency reserves to prepare themselves for a possible financial crisis in the future. Under the proposed global reserve system, countries would be encouraged to expend more money in an efficient and productive way. That's the goal of your proposal, isn't it?

A: Exactly. It's money not spent. For a good reason, people want to protect themselves. It's a precautionary saving. But, because it's not spent, it creates a deflationary bias.

One of the points is that if you have some countries not spending all their income, you have to have somebody else spending more than their income.

Now, my point is that all the countries in the world, except for one, had persuaded themselves they should not spend beyond their income. That left the United States as what I call "the consumer of last resort." That system was fundamentally flawed. It was a strange system, where, in order for the global system to work, the United States had to spend more than its income. It made no sense. And the United States said it was actually investing, but it could not even manage that investment. So, in a way, you could say, if the system were worked beautifully, the money could have gone to the United States. The United States could have invested it in high-return projects in other developing countries and they would have borrowed and the global economy would have grown well.

Q: European nations are currently contemplating the creation of a European version of the IMF (International Monetary Fund). Asian countries once tried to create an Asian Monetary Fund, but it was opposed by the United States.

What are your views about regional monetary funds such as the one being contemplated by the European nations?

A: I thought the proposal of Japan 12 years ago (to create an Asian monetary fund) was a very good proposal and I thought it was very shortsighted on the part of the United States and the IMF to oppose it. It was a mistake that was very costly, I think, to Asia and the world. I think it was a self-interested, that is to say it was a politically shortsighted, view that the United States was worried that it would lose political dominance. But its political influence has been more damaged by the subsequent events, by, for instance, the inconsistency of the policies in East Asia and the policies the U.S. government has now pursued. The fact that it resisted the Asian monetary fund gets enormous resentment.

Q: So you do support the idea of a European monetary fund?

A: Yes. I was very critical at the time the euro was created.

I said they needed to have an institutional framework for helping countries that were in trouble, otherwise the Euro would not work. It would work when things were good, but when there's a problem it would have difficulties.

Q: I believe your point is that the new global reserve system would make it unnecessary for countries to accumulate reserves and that they could therefore spend the money in a more efficient and productive way, such as investment in the area of environmental protection. What would you do if you were U.S. president?

A: There are two issues. One is on the "global system" and then let me talk about the United States.

I just hinted very briefly in my talk (in the forum earlier today) that the G-20 (Group of 20) proposal was for the United States to save more and for China to consume more. I was very critical of that because the United States should save more, but China should not try to imitate the U.S. consumption, because if China did that, the world is going to die. I mean, the planet can't survive if everybody consumes like the United States.

The problem with the world today isn't too much saving, but the fact is that the saving wasn't going to where it was valuable ... retrofitting the world for climate change, providing capital goods for people in poverty so they could increase their incomes. Well, China should consume a little bit more, but mostly (we need to) to figure out how to use that saving better.

In the United States, what I would say is, we need to invest a lot more in technology, education, infrastructure. Any visitor to the United States looks at our airports and looks at airports in Asia. I just traveled a little bit around Japan on your railroads, and there's no comparison between our railroads and Japan's. We shouldn't be in that situation.

Q: In your book "Freefall," you emphasize the need for redistribution of income in order to create more economic efficiency, through such steps as a progressive taxation system.

A: Yes, the problem of inequality is a real problem in the United States. So what basically happened was, on the positive side, the strongest part of the U.S. economy has been high-tech investment. But part of the weakness of the American economy was that we got growing inequality, which meant that most people could only continue to consume by borrowing, and that was a major flaw in the way our economic system worked.

And (redistribution of income) would increase aggregate demand without debt. The only way we could have aggregate demand with the inequality was allowing people to consume beyond their income, which was the "debt finance" system. And the only way that worked was with a bubble.

Q: Just as each country needs redistribution of income, does the international community also need it? You actually maintain that the global reserve system must be reformed.

A: Yes. The economics is the same. In a world of globalization, what matters is global aggregate demand, and if we can get more income to more of those who expend it, you'll get a more dynamic economy.

There's one other fact though, that I also emphasize, which is that for the short-run, part of the problem right now is that one of the real potential sources of demand is for global warming(-related) investment, but the market price system doesn't work because the price of carbon emissions is zero. If we corrected the price of carbon emissions to $80 (7,245 yen), then people would have an incentive to make the investments. So, that's the investment side.

And then what worries me over the longer-run is the investments in technology that we were talking about, on the private side, are based on advances in science financed by the government. So, like the Internet: the government did the basic Internet, and then the private sector spent billions to develop it.

What worries me is that, in the current context, in the budget cuts, we're cutting back on the investments in basic research, which will undermine the private-sector investments in 10 years or 5 years or 15 years.

Q: Some economists are still arguing that the idea of redistribution is close to that of the socialists. With many governments spending more to overcome the global economic crisis, many people are now worried about its negative impact on the future. What kind of exit strategy should we have?

A: Well, first, on the deficit issue, what matters is not the deficit today, but the long-term debt. If we spend money today on investments in technology, infrastructure and education, we lead to more growth today because we have excess capacity, we lead to more growth in the future because of the return on the capital, we get more tax revenue in the future. You can show that, for the United States, for instance, so long as the return on the capital is more than 5 percent or 6 percent, the long-term national debt was lower. So, deficit spending on investments is debt reducing in the long-term. What I say is that the financial markets are being shortsighted like they were in the lead-up to the (global financial) crisis, and that we should be focusing on the long-run and not the short-run.

There is another set of issues on the exit strategy. It's obviously premature for us to exit. The problem is that some of the ways that we intervened--and this is one of the points I'm trying to make in "Freefall"--are going to make the exit more difficult, and make it all the more important for us to keep up the fiscal support.

So for instance, one of the concerns is the "quantitative easing" (in which) the U.S. Federal Reserve has been buying almost all the mortgages. There is a real worry that when they stop buying them, even if they don't sell them, but if they stop buying them, the usual laws of demand and supply would say that the interest rates would rise, and the mortgage market is already in bad shape, and that will make the economy weaker. There's nothing they can do about it at this point, other than to maintain the fiscal support.

Q: Any advice concerning Japan's economic policy?

A: I think, probably, Japan needs to try to have a more comprehensive macro and micro policy. When I say "micro," you have to have those kinds of policy promoting technology and advanced education. I think that Japan needs to probably spend more on promoting technology to recover... You have a very good manufacturing (sector), but the rest of the economy has not been as dynamic.

And the second one is, on the macro-side, I would have more active policies to try to lower the exchange rate (of the yen) to make your manufacturing more competitive.

Q: You mean intervention is needed to lower the yen's value?

A: Yes, intervention and exchange rates, because the current exchange rate makes your industry less competitive. In effect, the United States has almost been encouraging a low value of the dollar, which has been hurting Japan. So, I think, in one way or another, (Japan) needs to take a more active stance in trying to make its economy more competitive, which would also be good for its overall macro-economy.