Herein lies the great paradox. Although no one likes the dollar standard, governments and private market participants still consider it the best option.

In fact, US trade deficits are primarily the result of insufficient, mainly government, saving - not a misaligned exchange rate, as economists have led policymakers to believe. Large US budget deficits during Ronald Reagan's presidency generated the famous twin fiscal and trade deficits of the 1980s. This, not an undervalued yen, caused the bilateral deficit with Japan to widen in the 1980s and 1990s.

The larger US fiscal deficits of the new millennium, courtesy of Presidents George W. Bush and Barack Obama, portend large - and indefinite - trade deficits. But US policymakers continue to blame China, claiming that the renminbi has been undervalued for the last decade.

The claim that exchange-rate appreciation will reduce a country's trade surplus is false, because, in globally integrated economies, domestic investment falls when the exchange rate appreciates. So the ill will that China-bashing is generating is for nothing. Worse, it detracts political attention from the US' huge fiscal deficit - $1.2 trillion (7.7 percent of GDP) in 2012 - and thus impedes any serious effort to rein in future spending for entitlements, such as healthcare and pensions.

Some contend that large fiscal deficits do not matter if the US can exploit its central position under the dollar standard - that is, if it finances its deficits by selling Treasury bonds to foreign central banks at near-zero interest rates. But the US' ongoing trade deficits with highly industrialized countries, particularly in Asia, are accelerating de-industrialization in the US, while providing fodder for US protectionists.

Indeed, the US' trade deficit in manufactures is roughly equal to its current-account deficit (the amount by which domestic investment exceeds domestic saving). So those concerned with job losses in US manufacturing should join the chorus lobbying for a much smaller fiscal deficit.

Can large US fiscal deficits and near-zero interest rates be justified because they help to revive domestic economic growth and job creation? Five years after the credit crunch of 2007 to 2008, it seems that they cannot. And, without even that justification, the latest wave of criticism of the US dollar standard appears set to rise further - and to stimulate the search for a "new" arrangement.

But the best new arrangement - and possibly the only feasible one - would follow an old formula: as in the 1950s and 1960s, the US would set moderately positive and stable interest rates, with sufficient domestic saving to generate a (small) trade surplus. The cooperation of China, now the world's largest exporter and US creditor, is essential for easing and encouraging the transition to this nirvana. Apart from the ongoing euro crisis, a stable renminbi/dollar exchange rate is the key to renewed (dollar) exchange-rate stability throughout Asia and Latin America - as envisaged in the original 1944 Bretton Woods Agreement.

Project Syndicate

The author is Professor Emeritus of International Economics at Stanford University, and the author of The Unloved Dollar Standard: From Bretton Woods to the Rise of China.

(China Daily 01/29/2013 page8)