China, Japan and South Korea agree on little these days. Yet they seem increasingly united in the belief that their economic sovereignty—their ability to control inflows and outflows of capital, and the consequences for their economies—is hostage to imprudent policy innovations coming from the U.S. Federal Reserve.
In December, Japanese Prime Minister Shinzo Abe observed critically that "Central banks around the world are printing money. . . . America is the prime example. If it goes on like this, the yen will inevitably strengthen. It's vital to resist this."
Speaking from Beijing in September, Bank of Korea Governor Kim Choong-soo said that "Korea and China need to make concerted efforts to minimize the negative spillover effect arising from the monetary policies of advanced nations," namely the United States.
The root of the problem, as People's Bank of China Governor Zhou Xiaochuan explained in a November 2010 speech, is that whereas U.S. monetary policy "may be optimal for the U.S. alone . . . it is not necessarily optimal for the world. There is a conflict between the U.S. dollar's domestic role and its international settlement role."
This conflict is a leftover defect of "the Bretton Woods system," he said, referring to the historic 1944 conference that anointed the dollar a unique surrogate for gold at the foundation of the global monetary system. By 1961, when the first nine European countries met the requirement that their currencies be convertible into dollars, this system was already coming under strain owing to a deteriorating U.S. balance of payments and corresponding loss of gold reserves. It collapsed 10 years later when President Nixon suspended the dollar's convertibility into gold in order to prevent the depletion of America's gold stock. But a lack of alternatives meant that the dollar remained the world's dominant reserve and trade currency, Mr. Zho noted, despite "the frequency and increasing intensity of financial crises" after 1971.
In the wake of the 2008 financial crisis, pundits and world leaders alike called for a new Bretton Woods to address the global financial imbalances that had become both dangerous and endemic. These imbalances have been created predominantly by the U.S. and China, which together account for a third of world gross domestic product.
Dollars sent to China for merchandise come back to the U.S. overnight in the form of low-interest loans and are then recycled through the U.S. financial system to create more cheap credit. No force acts to reverse Chinese trade surpluses or U.S. trade deficits—there is no sustained dollar depreciation to make U.S. goods more competitive, and no Fed tightening to restrain the growth of U.S. credit. The most dramatic effects of this have been seen in the U.S. housing market, where a bubble created by low interest rates and easy credit burst in 2007 with terrible effects on the global economy.
China has built up an astounding mountain of monetary reserves: $3.3 trillion, approximately 60% of which comprises U.S. government securities. The U.S. has accumulated the world's largest international debt: $15.9 trillion. Each government eyes the trajectory of the two stockpiles with trepidation—the Chinese fear a collapse in the global purchasing power of their dollar hoard, the Americans a collapse in funding for their debt. The U.S. accuses China of "manipulating" its currency, keeping it artificially low to stimulate exports and discourage imports, while China blames U.S. profligacy and lax monetary controls.
China is, unlike the U.S. in the 1940s, in no position to orchestrate a Bretton Woods-type refashioning of the global monetary architecture. The U.S. today is hardly the supplicant, war-torn Britain of the '40s, when the U.S. Treasury forced it to remove the remaining trade and currency convertibility restrictions that sustained the pound sterling's still-significant international role.
The U.S. still pays its bills in a currency it prints. Despite its large and growing debt, it has sold record new issues of it at record low interest rates in a time of trans-Atlantic financial crisis. The dollar still accounts for 60% of global foreign-exchange reserves (down from 70% a decade ago). Today 75% of global imports from countries other than the U.S. are still denominated in dollars. At present, America has no need to accommodate calls for it to sacrifice its exorbitant privilege to some vague vision of the global good.
China believes the U.S.-dominated international financial architecture fails to provide adequate security for its economic interests, yet it can identify no alternative blueprint that doesn't imply massive financial losses on its reserves, dislocation for its export industries, and potential social unrest.
The Bretton Woods saga unfurled at a unique crossroads in modern history. An ascendant anticolonial superpower, the U.S., used its economic leverage over an insolvent allied imperial power, Great Britain, to set the terms by which the latter would cede its dwindling dominion over the rules and norms of foreign trade and finance. Britain cooperated only because the overriding aim of survival seemed to dictate the course. The monetary architecture that the U.S. Treasury powered through a gathering of dollar-starved allies ultimately fell of its own contradictions: There is no stable, durable circumstance in which the U.S. can emit enough dollars to satisfy the world's trading needs and few enough to ensure that they can always be redeemed for a fixed amount of gold.
Many hope that the International Monetary Fund, created at Bretton Woods, can be the catalyst for a new cooperative monetary architecture. Yet history suggests that this won't occur until the U.S. and China come to the conclusion that the consequences of muddling on, without the prospect of correcting the endemic imbalances between them, are too great.
Meanwhile, trade tensions may grow much worse—as they did in the 1930s, during the last great international currency war. China's recent bilateral agreements with Japan, Brazil, Russia and Turkey to pursue trade without dollars could be a worrisome harbinger, insofar as each would be more likely to undertake global trade discrimination in order to balance its bilateral trade than to stockpile other currencies. The U.S. had sought to eliminate this damaging stratagem permanently at Bretton Woods; it may soon re-emerge.
Mr. Steil is director of international economics at the Council on Foreign Relations and author of "The Battle of Bretton Woods," just out from Princeton University Press.
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