Dollar Mystery and Tibet

These days, nobody seems to doubt that the U.S. dollar will lose its status as the world's reserve currency. To watch the financial news channels you would think that the dollar-yuan relationship is so unstable that the only question is whether it will be Ben Bernanke or Chinese monetary authorities who will determine the details of the breakdown. Perhaps the dollar won't surrender its anchor role so soon. And perhaps that loss, if it comes, will happen because of events that take place nowhere near men in suits at a central bank. Maybe the answer to the dollar's riddle can be found in the cellphone photo image of a Tibetan monk in crimson and orange squaring off with a Chinese soldier.

Two economists at Deutsche Bank AG, David Folkerts-Landau and Peter Garber, and a colleague, Michael Dooley of the University of California at Santa Cruz, are making the case that the dollar will remain an anchor. Their research concedes that the old dollar order, that of Bretton Woods, may be past. But it suggests we are in a second order, a Bretton Woods II, one that can be surprisingly stable.

The Deutsche Bank argument starts with facts on which we all agree. The Chinese regime made a deal with its people: It would give them jobs and cars. The people would allow the regime to stand. The Chinese leaders used exports to drive the growth that created those jobs. Their success put upward pressure on their own currency. To keep its own workers' exports cheap, the Chinese government resisted that pressure and intervened heavily in exchange markets, snapping up U.S. Treasuries.

Years ago, commentators began saying that Chinese monetary authorities would soon abandon the dollar for other currencies — the euro, say. Such statements are based on the belief that the most important number in the world was the U.S. current account, which was in deficit, i.e., unbalanced.

Shortly, the rest of the world would realize that the U.S. bought more than it sold and withdraw its cash from the debtor. Paul Krugman of the New York Times calls this the Wile E. Coyote moment — when you fall because you suddenly realize that you are past the cliff's edge and are standing on thin air.

Somehow, that realization hasn't come. The reason, the Deutsche Bank scholars say, is that other numbers are more important than the current-account deficit. Indeed, that deficit may be a good thing. "Contrary to almost universal opinion, successful economic development is powered by net savings flow from poor to rich countries," they wrote.

A number that does matter is the real interest rate in the U.S. and elsewhere, lower than it would otherwise have been because of Chinese growth and demand for dollars. Today, Americans can borrow more than they once expected thanks to China. Mr. Bernanke's predecessor as Fed chairman, Alan Greenspan, wrote about this in the Financial Times this week.

Another key number in the Deutsche Bank story is the Chinese government's growth target. That's important because the authorities are in a breakneck race with time.

There are still more than 100 million unemployed or underemployed Chinese workers to whom the regime has yet to deliver the promised employment. The authors calculate that it will take the regime many years to create jobs for those people. In that period, the Chinese need dollar-denominated capital to fund such an expansion.

If that government ceases to generate stupendous growth each year, those underemployed people will start joining demonstrations in places like Tibet, they will begin to find Internet censorship intolerable, and will think more about challenging Beijing.

American and European mayors see hosting the Olympic Games as a good way to get fame and some pricey infrastructure for their cities. Beijing sees the games as a lifesaver, the greatest advertisement ever made for a nondemocratic regime's commitment to its side of a jobs contract.

What could break Bretton Woods II? Politics. In the U.S., new protectionist laws passed by angry Republicans and narrow-minded Democrats could shut out imports from places like China, and the Chinese would no longer have any use for their dollar deal.

In China, the monetary authorities could lose their race against time. After all, in the past decade, instances of demonstrations or other forms of public unrest in China have risen tenfold.

A new regime in Beijing might pull the country left, and confiscate or redistribute all that new wealth. The old anti-capitalist laws are probably still on the books. Or new leaders — the monks — might make democracy, or even religious faith, a priority.

Or China might recede into years of ethnic chaos. In any of these cases, the new Chinese government won't be forced to deliver the same growth, and therefore won't spend commensurate energy tending the dollar.

This is just a sketch, but you get the point. Watch Mr. Bernanke, watch the European Central Bank, watch the Chinese authorities — but also watch the rest of the country. The flash of orange in the robe of the monk is important enough to change the picture for the greenback.

Miss Shlaes, a senior fellow in economic history at the Council on Foreign Relations, is a columnist for Bloomberg News.