Of all the issues that the leaders of the G20 nations agreed in Pittsburgh to confront going forward, none is more consequential than that of global imbalances. The U.S. and China - "Chimerica", as historian Niall Ferguson has labeled the symbiotic pairing - are at the heart of the adjustment problem. The other 18 will largely be dragged along for the ride.
History tells us that with no change of course by the U.S. or China, financial crises, protectionism, and political conflict are inevitable. Inflation during World War I led to the rise of monetary nationalism in the 1920s and the collapse of the gold standard, which paved the way for the stock market bubble, the crash, and the Great Depression. The huge imbalances in global gold reserves and export capacity that developed during World War II forced a return to bilateralism in trade and liquidation of the British Empire. The transformation of the global dollar shortage into a dollar glut in the 1960s led to the collapse of the Bretton Woods gold-exchange standard system, and paved the way for the stagflation of the 1970s. The serial currency crises of the 1980s and ‘90s led affected countries to pursue an active strategy of dollar accumulation, and fueled the runaway U.S. deficits of the current decade.
The present economic crisis has only affirmed those countries' belief in the importance of exchange rate management. Meanwhile, the U.S. abjures the use of tighter monetary policy to control the effects of recycled dollars on U.S. credit growth, seeing itself as a helpless victim of a "global savings glut".
This leads us to the current standoff, with the Chinese government, owner of over $2 trillion in reserves, calling for the U.S. to tighten its monetary and fiscal policy, and the U.S. government, borrower of $1.8 trillion over the past 12 months, calling for China to loosen its exchange rate policy. In Pittsburgh, they could agree only that the International Monetary Fund should review their policies, each knowing that the Fund can in the end do no more than urge flexibility on one side and prudence on the other.
The irony of the U.S. position is that the IMF was constituted according to a blueprint laid down by Harry Dexter White and President Roosevelt's Treasury team during World War II, with the explicit mission of maintaining a global fixed exchange rate system. The U.S. position was that the economic chaos of the 1930s was the result of countries failing to sustain their solemn obligations to maintain agreed exchange values for their currencies. Even John Maynard Keynes, the intellectual father of national economic sovereignty, categorically rejected floating exchange rates as a basis for the post-war system.
China began its policy of fixing the yuan to the dollar in 1994, as part of its strategy of integrating into the global economy. Roosevelt's Treasury would have heartily approved. During the Asia crisis of 1997-98, China sustained its policy in spite of high market and political expectations that it would follow its neighbours and devalue. "China, by maintaining its exchange rate policy, has been an important island of stability in a turbulent region," pronounced Robert Rubin, President Clinton's Treasury secretary, in May 1998.
How times have changed. Just a few years later, with pressure on the yuan now upwards against the dollar instead of downwards, the U.S. discovered the hidden eternal virtues of floating exchange rates. Writing in the Wall Street Journal in September 2006, Senators Charles Schumer and Lindsey Graham turned the intellectual history of economics on its head by declaring flatly that "One of the fundamental tenets of free trade is that currencies should float." (Explain that one to Keynes.) And in January of this year, then-nominee for Treasury secretary Timothy Geithner told the Senate Finance Committee that China, in pursuance of the same policy that exacted such praise from Robert Rubin in 1998, was now "manipulating" its currency, and that the Administration would act "aggressively" to put an end to it.
"When the facts change," Keynes once famously remarked, "I change my mind. What do you do, sir?" And the facts have clearly changed for the United States. They are no longer the creditor nation they were during World War II, controlling most of the world's gold reserves. They are now a massive debtor. So they have changed their minds. Fixed exchange rates were good when their trading partners were devaluing against them. Floating exchange rates are good now that they wish to devalue against their trading partners. There is perfect consistency in narrow self-interest.
As for China, expect it to continue to see the same virtues in exchange rate stability that the U.S. saw over its first two centuries of nationhood. But this does not mean passivity on the question of dollar reserve accumulation. China's initiative with Brazil and Russia to conduct two-way trade sans dollars is its most important one. And it is also the most worrisome, in terms of the survival of the multilateral trading system. As China clearly has no intention of stockpiling Brazilian reais or Russian rubles, the only way for China and others to conduct trade without an internationally accepted currency, like the dollar, is to balance it bilaterally with their partners. This means trade discrimination, of the sort the U.S. fought relentlessly to eliminate at Bretton Woods.
The U.S. must accept that it will not be possible to devalue its way out of its savings problem, as it will undermine global confidence in the dollar as a reliable store of value and the bedrock of the multilateral trading system. As Chinese central bank governor Zhou Xiaochuan observed in March, "Issuing countries of reserve currencies . . . cannot simply focus on domestic goals without carrying out their international responsibilities." The U.S. has yet to demonstrate the will to shoulder such responsibilities.
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