Abstract
The evolution of the International Monetary System has seen China emerge as a leading peripheral nation in what has been commonly referred to as the New Bretton Woods Regime. As a nation, China has achieved development through export led growth, supported by undervalued exchange rates and capital controls. However, in doing so China has not only accumulated vast amounts of dollar reserves of the Center Country, USA, but has also played a major role in financing US’ current account deficit. This paper seeks to explain why the current system is not sustainable in the long run and what impact maintenance of stats quo would have on China’s financial system.
I. Introduction
The global current account deficit of the United States reached an unprecedented height of over $800 bn. or almost 7% of the US GDP in 2006 before falling to around $740 bn. in 2007. With a net foreign debt of $2.4 trillion or close to 17% of its GDP, the world’s largest economy and center of military power is also the world’s largest debtor. Moreover, the dominant feature of the current world financial system is that this hefty US external deficit is actually financed by the world’s central banks at a low cost. As a result, the US gets to consume more than it produces, and finance budget deficits cheaply, while strong exports based on undervalued currencies propel East Asia, and particularly China, forward with rapid industrialization.
By tying their currencies to the dollar, formally or informally, Asian Economies have constituted what Dooley, Folkerts-Landau and Garber have referred to as a “New Bretton Woods System.” This new system, like its post World war II predecessor, has the US as its center country, with a ...