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February 28, 2005

Economist Dooley at center of debate over Asian investment in U.S. economy

By Jennifer McNulty

Economist Michael Dooley is spending a lot of time explaining himself lately. That's what happens when a leading international economist becomes a vocal proponent of today's high levels of Asian investment in the U.S. economy.

Photo: Michael Dooley

UCSC economist Michael Dooley argues that Asian investment guards against the prospect of a U.S. downturn.
Photo: r.r. jones

Dooley, a professor of economics, and two associates with Deutsche Bank, stand virtually alone in their analysis, but their views have triggered widespread discussion and international media attention.

Conventional wisdom says that large U.S. fiscal and current account deficits make the U.S. vulnerable to an economic downturn: It's only a matter of time before foreign investors sour on the deficit-riddled U.S. economy and sell off dollar assets, causing interest rates to jump and the value of the dollar to plunge. The bigger U.S. deficits are at the time, the bigger the potential "shock" of a sell off.

But Dooley argues that conventional wisdom doesn’t fit today’s scenario. The United States is in the midst of a "quite vigorous economic expansion," and although U.S. international borrowing is high (6 percent of gross domestic product), Asian investment actually guards against the prospect of a U.S. downturn. A constriction of credit to the United States would increase long-term interest rates and generate a "major shock," said Dooley, but a "large and meaningful block of countries in Asia" won't allow their currencies to go up, thereby assuring a steady flow of money to finance U.S. debts, he said. China is willing to fund the U.S. deficit as part of its development strategy, and that makes all the difference: "It's okay to have deficits if somebody's willing to buy your securities," he said.

Dooley’s views have been covered by the Economist, Financial Times, Financial Post, Business Week, the San Francisco Chronicle, and others, and the San Francisco Federal Reserve Bank recently invited more than 30 economists--including Dooley and his Deutsche Bank coauthors--to a symposium focused on their work.

For all the international media coverage, however, little attention has focused on what Dooley called the truly "revolutionary" aspect of this almost symbiotic relationship between the United States and Asia. Joined by Peter Garber and David Folkerts-Landau of Deutsche Bank, Dooley likens the current situation to the 1950s and '60s, when the Bretton Woods system helped war-ravaged Western European nations rebuild by pegging exchange rates to the dollar.

Since the early 1980s, countries like Hong Kong, Taiwan, Malaysia, and Korea have purchased U.S. dollars to keep their currency undervalued, which has fueled the export-led growth that has transformed their countries. Dooley calls it a de facto economic development strategy that works.

An expert on Latin American debt and development, Dooley has witnessed the failure of development strategies that rely on rich nations lending money to the governments of poor countries. History has shown that government protections get in the way, employment and production never take off, and the debts are never repaid, said Dooley, who sees a potential win-win scenario in the interaction today between the United States and China.

Calling the scale of unemployment in China today "no less a problem than the Great Depression," Dooley said that as long as China remains locked into U.S. securities, the dollar will remain strong and U.S. consumers will continue to gobble up Chinese-manufactured goods. That consumption is financing China's own rapid development--employing its enormous work force, raising wages, and ultimately creating a nation of Chinese consumers with an unparalleled appetite for goods and services. Unlike the strategies that failed in Latin America, today's scenario eliminates protectionist policies and "makes developing countries compete from the start in international markets," noted Dooley.

A successful outcome depends on rapid development in China, which Dooley projects will take a decade or so.

"Chinese currency will rise as wages rise, and they'll be holding dollars," said Dooley. "They'll lose on those. That's why this is a transitional policy. It can't last forever. But as long as it's gradual, it doesn't have to end in a bang."

Right now, Dooley emphasized, the priority for China's leaders is to develop their capital stock, promote high levels of direct investment, and build markets for their industrial output. "It's in their self-interest," he said.

If, however, private speculators buy up undervalued Chinese currency, it could force the Chinese to allow the yuan to appreciate, and the impact on the U.S. economy would be "even worse than what our critics are saying," he conceded. That scenario underscores the high stakes involved, but Dooley shows no signs of unease about holding a minority viewpoint. "People don't understand enough about the history of the system they live in," he said.

Dooley acknowledged that rapid Chinese development will trigger social and environmental problems. "But what's the alternative? Do you want 200 million unemployed Asians?" he asked. "I'd rather see them rich and prosperous, more like Japan than Argentina."

"China and other Asian countries won't allow their currency to go up, and Argentina and Brazil are resisting the appreciation of their currency," said Dooley. "Mexico and Latin America are starting to follow the Asian model. I think it will work."

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