A Global Free-For-All?

But overreliance on the dollar can also backfire, as it now has. Not only have countries suffered declines in exports to a slumping U.S. economy. They've also lost dollar loans needed to finance trade with third countries. "When the crisis hit, U.S. banks cut back on dollar credit lines to foreign borrowers," says David Hu of the International Investment Group. The additional IMF loans endorsed at last week's summit aim to offset these losses.

Given the dollar's drawbacks, why not switch to something else, as Zhou suggests? The trouble, as even he concedes, is that there's no obvious replacement. The attraction of an international currency depends on its presumed stability, what it will buy and how easy it is to invest. The euro (27 percent of government reserves) and the yen (3 percent) don't yet rival the dollar. As for China, it hasn't even made its currency (the renminbi, or RMB) freely convertible for Chinese investments. Zhou mentions relying more on "special drawing rights" (SDRs). But SDRs are not a real currency. They're synthetic money issued by the IMF that can be converted into a mix of dollars, euros, yen and pounds.

We are stuck with the dollar standard for many years. To work, it requires that countries with huge trade surpluses reduce the export-led growth that fed the system's instabilities. The Chinese increasingly recognize this. "They're very aware of the need to promote [domestic] consumer spending," says economist Pieter Bottelier of Johns Hopkins University. In November, China announced a "stimulus" of 4 trillion RMB ($586 billion). In addition, says Bottelier, the government is expanding health and pension benefits to dampen households' need for high savings.

But China also has a default position: promote exports. It has increased export rebates; it has engaged in RMB currency "swaps" with trading partners (the latest: $10 billion with Argentina) that seem designed to stimulate demand for Chinese goods; it has stopped a slow appreciation of the RMB. China seems comfortable advancing its economy at other countries' expense. The significance of Zhou's pronouncement is political. It rationalizes this sort of predatory behavior: if we are innocent victims of U.S. economic mismanagement, then we're entitled to do whatever's necessary to insulate ourselves from the fallout.

Down this path lies continued instability and growing mistrust. The global economy is suspended between the lofty rhetoric of last week's summit and the gritty realities of domestic politics. We've already seen more protectionism. A World Bank study found that 17 countries in the G20 had recently adopted policies that discriminate against imports or favor domestic production. Though mostly modest in themselves, they "open the door for a lot of other opportunistic measures," says Gary Hufbauer of the Peterson Institute. Precisely. The deeper the recession goes—and the longer recovery is delayed—the greater the danger of economic strife.

© 2009