A Global Free-For-All?

We are in a race between economic recovery and economic nationalism. At last week's G20 summit, leading nations agreed to roughly $1 trillion of additional lending, mostly through the International Monetary Fund, to end the worldwide slump. But beneath the veil of consensus, countries are maneuvering to protect their economies and blame someone else for the crisis. Will the world economic order overcome these stresses or give way to a global free-for-all, characterized by rampant protectionism, nationalistic subsidies and preferences?

Emblematic of the tension is a recent proposal by Zhou Xiaochuan, governor of the People's Bank of China (PBOC), to replace the dollar as the world's major international currency. In a paper posted on the PBOC's Web site, Zhou argued that the present crisis reflects "the inherent vulnerabilities and systemic risks" of the dollar-based global economy. The PBOC is China's Federal Reserve, meaning that Zhou is no obscure bureaucrat or renegade academic. His critique is a significant event.

It may surprise Americans that, up to a point, his analysis is correct. The dollarized world economy developed huge potential instabilities—vast trade imbalances (American deficits, Asian surpluses) and massive, offsetting international money flows. But what Zhou omits from his analysis is revealing. To wit: China and others are implicated in the dollar system's failings. By keeping their currencies artificially depressed—a way to aid exports—they abetted the very imbalances that they now criticize.

The Chinese denounce American profligacy after promoting it and profiting from it. Low prices of imported consumer goods (shoes, computers, TVs) encouraged overconsumption. From 2000 to 2008, the U.S. trade deficit with China ballooned from $84 billion to $266 billion. China's foreign-exchange reserves are now an astounding $2 trillion. The reserves are not an accident; they are the consequence of conscious policies.

It's not just that exchange rates were (and are) misaligned. American economists have argued that a flood tide of Chinese money, earned from those bulging trade surpluses, depressed interest rates on U.S. Treasury securities and sent investors searching for higher yields elsewhere. That expanded the demand for riskier securities, including subprime mortgages, and pumped up the real-estate bubble. So China's policies contributed to the original financial crisis (though they were not the only cause) as well as to Americans' excess spending.

For decades, dollars have lubricated global prosperity. They're used to price major commodities—oil, wheat, copper—and to conduct most trade. Countries such as Thailand and South Korea deal in dollars for more than 80 percent of their exports, notes economist Linda Goldberg of the Federal Reserve Bank of New York. The dollar also serves as the major currency for cross-border investments by governments and the private sector. Indeed, governments hold almost two thirds of their $6.7 trillion in foreign-exchange reserves in dollars.