The dollar has fallen about twenty percent against the Euro in the last year but China and Japan continue to accumulate large dollar surpluses. At the same time, many economists worry that they will dump their holdings, sending the dollar into a free fall.
Michael Dooley, Peter Garber, and David Folkerts-Landau suggest that this financial policy is no accident. They view the Chinese and Japanese as pursuing deliberate full employment policies. They buy and hold dollars, not as an investment, but rather to subsidize their own exports. Read this summary of the argument, or buy an NBER working paper here. Garber puts the point bluntly:
“The fundamental global imbalance is not in the exchange rate,” Garber told the IMF forum in November. “The fundamental global imbalance is in the enormous excess supply of labor in Asia now waiting to enter the modern global economy.”
Garber estimates that there are 200 million underemployed Chinese who must be integrated into the global economy over the next 20 years. “This is an entire continent worth of people, a new labor force equivalent to the labor force of the EU or North America,” he explains. “The speed of employment of this group is what will in the end determine the real exchange rate.”
Garber likens the global labor imbalance to the collision of two previously independent planets — one capitalist and one socialist. “Suddenly they were pushed together to form one large market,” he says. The best way to restore equilibrium is for the former socialist economies to pursue export-led growth — and for the United States to act as a buffer and absorb the world’s exports.
Brad DeLong says he doesn’t believe the argument because the U.S. trade deficit is too large relative to the American economy. Brad predicts a revaluation of the Asian currencies within three years. Garber predicts that the new arrangement can last until another 200 million migrating Chinese find jobs. Either scenario would be better for the U.S. economy than some of the scare stories suggest. A weaker dollar in Asia would help correct the U.S. trade imbalance and it is unlikely that the Chinese would allow the yuan to rise so rapidly that the dollar would plummet. And if the current arrangement can continue, so much the better. The bottom line is this: the world economy, in real terms, is drawing on a massive “free lunch,” namely migrating Chinese labor.