Mike Dooley of Deutsche Bank and UCSB makes the case that the new Bretton Woods system of fixed or heavily managed exchange rates on the "periphery" makes large (though not necessarily growing) current account deficits in the "center" sustainable. He argues that this system "works" both politically and economically, and therefore it is fundamentally stable. I argue that it is not.
Mike Dooley hardly needs introduction. He (and his colleagues at Deutsche Bank) wrote the seminal paper arguing that the current international monetary system is defined by the decision of key emerging economies to intervene heavily in the foreign exchange market to maintain dollar pegs or to keep their currencies from rising by too much against the dollar. I certainly enjoyed the debate, and I hope Mike Dooley did too. Check out the Wall Street Journal online.
I intend to flesh out a couple of points that came up in the debate over the course of the week.
One is that the nature of the system - even if lasts - has to evolve from what I called a "win/win" system, with fast growing exports in the "periphery" and falling real rates in the center, to a "don't lose"/"don't lose" system, as emerging economies add to their reserves to sustain their existing level of exports and to keep US (and European) interest rates from rising. The fun part of Bretton Woods II hinged on an expanding US trade deficit. But at some point, the trade deficit has to start to shrink just to keep the US current account deficit constant. That implies the pace of US import growth has to slow substantially. Think 5% a year nominal GDP growth, 5% a year US import growth (i.e. imports stay constant as a share of GDP) and US export growth of more than 8% a year.
The other is that the currency regimes of oil exporters have made them a key part of the Bretton Woods II system. Both Saudi Arabia's dollar peg and China's de facto dollar peg are impediments to global adjustment.