The best alternative to a new global currency

By Joseph Stiglitz

Published: March 31 2011 20:12

The international monetary system needs fundamental reform. It is not the cause of the recent imbalances and current instability in the global economy, but it certainly has been ineffective in addressing them. So a broad set of reforms is required, beginning with an immediate expansion of the current system of special drawing rights or money that can be issued by the International Monetary Fund. And here the Group of 20 leading nations must take the lead.


John Maynard Keynes once proposed a global currency, the Bancor, to be placed at the centre of the international monetary system. The idea never caught on. Instead, we now have a system dominated by holdings of US dollars. This has several disadvantages. The first is it creates a global recessionary bias during and after financial crises – because it places the burden of adjusting to payments imbalances on nations which run a deficit.

The second is the tension it creates, due to the use of a national currency, the dollar, as the global currency. This can lead to global volatility as a result of growing US current account deficits. These deficits are necessary, for creating sufficient global liquidity, but they also generate excessive indebtedness, both external and internal. So if the US were to shrink its deficit too quickly, a deficiency of supply of the global reserve currency could result.


Responses to global financial instability creates the third problem, where developing countries have accumulated large reserves as “self-insurance” against a future balance of payments crisis. These protect them during crises, but also add to global imbalances.


In the late 1960s a more limited global currency was created: the SDRs, issued by the IMF when enough member countries agree. The largest such issue – equivalent to $250bn, and suggested by the G20 in April 2009 – was an enlightened response to the dramatic collapse in international private lending after the global financial crisis. It helped soften the negative impact of the crisis on growth.


Now, in the same way, the global role of SDRs should be increased, both through new issues and a bigger role for SDRs in IMF lending. New SDR issues could be introduced in times of declines in private capital flows or large falls of global commodity prices. These would increase the ability of current account deficit countries, such as Pakistan or Egypt, if they were hit by an external shock.


In practical terms the G20 should encourage the IMF to issue a significant amount of new SDRs during the next three years, up to a value of $390bn a year. Such a move would have a number of benefits. It would reduce the problem of recessionary bias, by allowing central banks to exchange SDRs for hard currency, such as dollars or euros, and use it to finance higher imports. It would partially replace countries’ need to accumulate reserves.

Given its relatively small scale, more SDRs would also help to sustain and accelerate recovery of the world economy, without leading to inflationary pressures. And by reducing the need for countries to set aside foreign exchange reserves, it would also facilitate some reduction in global imbalances.


New measures to increase the effectiveness of SDRs themselves are also needed. One way would be for the IMF to use these SDRS to finance lending to countries that need short-term financing, due to balance of payments constraints, as happened recently in Greece and Ireland. Eventually SDRs could become the main, or even the only, mechanism for IMF financing.


Further, when crises occur in many countries simultaneously, as happened, for instance, during the 1998 east Asian crisis, IMF lending could be totally financed by new SDR issues in unlimited amounts. If and when the world economy recovered or boomed, SDR issues could then cease, or even be reabsorbed. Thus the IMF would have a greater role in creating official liquidity, in a way that curbed both recessionary and inflationary trends at different times.


All of this would make a contribution to enhancing global stability, without altering in any fundamental way existing monetary arrangements. And the dollar would continue as the main currency for private transactions, making this change more acceptable to the US.


The G20 showed its effectiveness in responding to the financial crisis. The question today is, with the passing of the worst and emergence of large divergences in perspectives, can the G20 again demonstrate the leadership the world needs? A swift expansion of the SDR system would show this continued leadership. More importantly, it would also ensure greater stability and more sustained growth in the world economy.


The writer is a recipient of the 2001 Nobel Memorial Prize in economics and University Professor at Columbia University.

This article is drawn on a statement issued by Mr Stiglitz, together with a further 17 leading economists (called “the Beijing Group”), following a recent meeting held in Beijing co-organised by the Initiative for Policy Dialogue at Columbia University and the Central University of Finance and Economics. The names of the Beijing Group are: Professor Joseph Stiglitz, Professor Jean-Paul Fitoussi, Professor Haihong Gao, Professor Stephany Griffith-Jones, Professor Yiping Huang, Professor Peter Kenen, Professor Jing Li, Professor Jose Antonio Ocampo, Professor Yaga Venugopal Reddy, Dr Ulrich Volz, Professor Robert Wade, Mr Benhua Wei, Professor John Williamson, Professor Wing Thye Woo, Professor Geng Xiao, Professor Yu Yongding, Professor Liqing Zhang, Professor Zhu Andong


Copyright The Financial Times Limited 2011.