The Asian Dollar Mystery

By David Ignatius

Washington Post
Tuesday, January 6, 2004; Page A17

The new year begins with a financial mystery: Why have China and Japan continued to accumulate large dollar surpluses -- financing the U.S. trade deficit in the process -- even as the value of those dollars has continued to plummet?

The Asian dollar hoard certainly looks like a stupid investment. The dollar, after all, fell about 20 percent against the euro last year because of worries about U.S. trade and fiscal imbalances. And many analysts (me included) have warned that a further sharp slide is likely this year as China and Japan begin to dump their surplus greenbacks.

Among the leading worriers is the International Monetary Fund, which warned in its latest "World Economic Outlook" in September that a further decline in the U.S. currency is likely and that "a disorderly adjustment -- or overshooting -- remains an important risk."

But let's consider a contrarian answer to our New Year's financial puzzle: Perhaps the Asian nations are pursuing an entirely rational strategy -- one that seeks to maximize domestic employment rather than financial return. If that's so, then financial traders can stop fretting so much and applaud a dollar that's playing much the same stabilizing role it did 50 years ago, during the golden days of Bretton Woods.

This counterargument was presented to an IMF forum two months ago by Deutsche Bank economist Peter Garber. If an abstruse economic theory can be said to be generating "buzz," that has happened with Garber's work.

Garber argues that Asia's seemingly irrational accumulation of surplus dollars is the inevitable consequence of its export-led development strategy. To increase domestic employment, the Asians keep their exchange rates artificially low and sell cheap goods to the United States -- in the process accumulating those ever-larger surpluses of dollars.

"The fundamental global imbalance is not in the exchange rate," Garber told the IMF forum in November. "The fundamental global imbalance is in the enormous excess supply of labor in Asia now waiting to enter the modern global economy."

Garber estimates that there are 200 million underemployed Chinese who must be integrated into the global economy over the next 20 years. "This is an entire continent worth of people, a new labor force equivalent to the labor force of the EU or North America," he explains. "The speed of employment of this group is what will in the end determine the real exchange rate."

Garber likens the global labor imbalance to the collision of two previously independent planets -- one capitalist and one socialist. "Suddenly they were pushed together to form one large market," he says. The best way to restore equilibrium is for the former socialist economies to pursue export-led growth -- and for the United States to act as a buffer and absorb the world's exports.

If this all sounds a bit like the world after 1945, that's the point. What's really going on is a revival of the Bretton Woods financial system that created the IMF, Garber and two other economists noted in a paper that was published in September by the National Bureau of Economic Research.

"In the Bretton Woods system of the 1950s, the U.S. was the center region with essentially uncontrolled capital and goods markets," they write. That, in effect, is the sort of world that has now returned, contend Garber and his fellow authors, Michael P. Dooley and David Folkerts-Landau.

Without realizing it, the authors argue, we have returned to a fixed-exchange-rate world, with China and other Asian developing countries keeping their currencies artificially low by pegging them to a falling dollar. The Asians today are like the Europeans after World War II -- using cheap exports to the United States to power their economic revival. And the wonder of it is that this neo-Bretton Woods system works as well as the old one did.

"In spite of the growing U.S. deficits, this system has been stable and sustainable," Garber and his co-authors argue. They cite the 1965 comment of French analyst Jacques Rueff about why the United States prospered under the old Bretton Woods regime despite its big trade deficits: "If I had an agreement with my tailor that whatever money I pay him returns to me the very same day as a loan, I would have no objection at all to ordering more suits from him."

To be sure, this perpetual motion machine can't continue forever. At some point, those 200 million Chinese will find jobs, and China will graduate to parity with the United States. At that point, we'll have a real dollar crisis.

Along the way, we're sure to have more political protests from American workers who fear their jobs are being sacrificed in this neo-Bretton Woods world. But for now, perhaps Wall Street should be less gloomy about the dollar.