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Email this citationCIAO DATE: 08/05
China's Role in the Revived Bretton Woods System: A Case of Mistaken Identity
Morris Goldstein and Nicholas R. Lardy
March 2005
Abstract
According to a popular argument put forward by three Deutsche Bank economists (Dooley, Folkerts-Landau, and Garber, hereafter DFG), one needn't worry about the sustainability of either the large US current account deficit or the undervalued exchange rates of a group of Asian economies (Dooley, Folkerts-Landau, and Garber 2003, 2004a, 2004b, 2004c; Folkerts-Landau 2004). In their view, the United States and the Asian economies have entered into an implicit contract-the so-called revived Bretton Woods system (hereafter BW2)-that can comfortably carry on for another decade or two, with significant net benefits to both parties.
For its part, the United States obtains a stable and low-cost source of funding for its large current account deficit-estimated to have hit an all-time high of $660 billion or 5.5 percent of US GDP in 2004, with many analysts projecting even larger deficits over the next several years (Cline forthcoming, Mann 2004). Absent the large-scale purchases of US Treasury securities by Asian governments, US interest rates (particularly at the short end of the yield curve) would be higher and the financing of the US external deficit less secure, inducing a more painful and perhaps more chaotic adjustment to the US saving-investment imbalance. In addition, a welcoming attitude toward foreign direct investment (FDI) in these Asian countries permits US companies to make good use of a low-cost and productive Asian labor force, generating supranormal profits for these investors.
From the perspective of the Asian countries, their prolonged, large-scale exchange market intervention limits or even prevents their currencies from rising in value against the US dollar. The undervaluation of their currencies, in turn, is said to underpin an export-led development strategy that produces economic and employment growth that is high enough to keep the lid on potentially explosive social pressures emanating from large pools of surplus labor.
