Comments on M. Dooley and N. Roubini: A new Bretton Woods system?

Abstract

These excellent papers focus mainly on one issue: the question of a hard landing for the US Dollar. This is far from the only question raised by monetary arrangements across the Pacific. But I will start with the hard landing—discussing its drivers and mechanisms—and then go on to consider other costs and risks, and some wider implications of the very different experience we are having within Europe and within the Pacific region. Regarding drivers, the fundamental questions in the papers are: what is driving developments in the fixed rate Pacific region; and if this is mainly China, does that mitigate risks of a hard landing? First, I accept Nouriel Roubini’s description of the structural deterioration in the US fiscal deficit as a separate and exogenous driver. There are countries for which “financing ease” can drive the fiscal deficit, but this has not been the case for the United States, where budgetary developments are unarguably driven “above the line.” Nonetheless, I do see the dominant and most significant driver in our present context being the policies of countries, such as China, that are preventing real appreciation. In the case of China, I agree with Michael Dooley that this has to be viewed as a matter of development strategy. That strategy is concerned not only with export-driven growth (which, as Nouriel says, does not require large trade surpluses). It is concerned also with an insurance motive of holding large reserves to ensure policy autonomy in the face of shocks. In the view of many observers, the strategy is also designed to cushion adjustment in the domestic financial system. I can well imagine that China has internalised the cost of future capital losses on its US Treasury bond holdings as part of that strategy. Like Nouriel, I do not completely buy the “total return swap” argument. But I do think that China’s strategic approach IEEP (2006) 3:333–336 DOI 10.1007/s10368-006-0065-1