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2009-03-18 | All chapters

Stiglitz On China's Svgs Hoard
James T. Areddy, Wall Street Journal, 17th March 2009

Blame the class of '97, including its valedictorian China.

For Nobel laureate Joseph Stiglitz, a starting point for rebuilding the world economy is recognizing how a 'global insufficiency of demand' set the stage for a crisis in the first place. In a talk Sunday in Shanghai, Stiglitz blamed risk taking by the U.S. Federal Reserve, along with U.S. regulators, as setting up the U.S. economy - and by extension the world - for a collapse.

That collapse was set in motion years ago, when the U.S. was keeping interest rates low and credit abundant for consumers and home buyers. A reason: authorities were working double-time to bolster demand to offset how weak it was elsewhere in the world.

Too many countries began saving too much instead of spending at home, and usually that savings took the form of U.S. Treasury bonds, he said. That gave Washington the world's cash to play with, while deeper problems in other nations, such as the widening gap between rich and poor, went unaddressed.

Stiglitz calls the savings glut nations graduates of 'the class of '97.'

In 1997, Asia fell into a devastating regional crisis that appeared to do the most damage to countries (Thailand, South Korea and Indonesia) that didn't have enough reserve of U.S. dollars to defend their own plunging currencies.

If the lesson was that a horde U.S. dollars was needed to insulate an economy from shocks, China earned an A+. At the end of 1996 - months before Thailand depleted its reserves almost overnight in a futile effort to prop up the baht - China had foreign exchange reserves totaling a respectable $107 billion. By the end of last year, Beijing's balance ballooned toward $2 trillion. Last year, China emerged as the world's largest investor in U.S. government debt and Washington's largest creditor.

'The dollar reserve system is part of the problem,' Stiglitz said at his talk Sunday. He stopped short of blaming Beijing explicitly, but he made it clear China needs to radically rethink its defensive strategy.

China has denied it shares the blame for the current global mess, saying savings is part of Chinese culture and that U.S. authorities were at fault for encouraging profligate lending.

Stiglitz isn't simply arguing China should rebalance its reserve holdings, such as buying more euros and fewer U.S. dollars. 'A two currency system can be even more unstable than a single reserve system,' he says, noting how views might change daily on whether the U.S. or Europe was a better investment.

Nor is Stiglitz saying China should exit U.S. holdings because Washington might not be able to honor all the debt it is building up, as China Premier Wen Jiabao last week hinted worries him.

'I don't think there is any risk of default,' Stiglitz says. Still, he suggests Beijing may look at securities that might insure against the inflation many believe will ultimately hit the U.S., including Treasury Inflation Protected Securities, or TIPS.

Stiglitz instead challenges the notion of reserves themselves. It is partly a dig at the International Monetary Fund, Stiglitz's longtime nemesis - his opposition to its prescriptions for Asia cost him his job in 2000 as top economic adviser at the World Bank - and which later instructed central bankers that a lesson of the late 1990s crisis was 'importance of gross reserve and related data.'

Often contrarian, Stigliz is now calling for a restructuring of the system under which each nation keeps its own war chest. 'We need a global reserve system,' he says. China and Asia could propel its development without a global consensus by building on an agreement called the Chiang Mai Initiative that in principle would allow one country to use another's money.

Source: http://chinese.wsj.com/gb/20090317/chj110457.asp?source=UpFeature

The European Chamber's Beijing Chapter will hold a Breakfast Seminar with Professor Stiglitz on 20th March. For more information about this event, please click here.