Today’s American mercantile pressure on China to appreciate the renminbi against the dollar is eerily similar to the American pressure on Japan to appreciate the yen that began over 30 years ago. Indeed, the yen went all the way from 360 to the dollar in August 1971, at the end of the Bretton Woods period of fixed exchange rate parities, to touch 80 to the dollar in April 1995. Then the American government relented and announced a strong dollar policy that signaled the end of “Japan bashing”. But the overvalued yen, and the expectation of appreciation, destabilized the Japanese financial system; the bubble economy of the late 1980s was followed by a deflationary slump and a zero-interest liquidity trap in the 1990s [McKinnon and Ohno 1997]. At least some of today’s critics of East Asian countries ’ pegging to the dollar would agree that international saving imbalances rather than misaligned exchange rates are the root cause of the U.S. current-account deficit. One can argue whether it is mainly a saving deficiency in the United States or a saving glut in the rest of the world [Bernanke 2005]. Either way, the central position of the United States under the world dollar standard gives it alone an unlimited international line of credit in its own currency. However, suppose that the U.S. trade deficit is misdiagnosed to result from a misaligned exchange rate, so that a surplus country on the dollar’s periphery is forced to appreciate against the world’s dominant money. It will suffer a slowdown in economic

I. Introduction and summary of main conclusions, 684. — II. A model with three tradable goods usable in production or consumption, 588. — III. Intermediate products, production technology, and the gains from trade, 601. — IV. The structure of production in protected industries, 610.

The choice of methods of production as related to factor costs is formulated differently from the ordinary production function by means of a particular activity set. Continuous factor substitutability is maintained in an ex ante sense. The resulting formulation is more amenable to existing data and is applied via a distributed lag model.

In the 1950's and 1960's a strong dollar standard existed; under fixed exchange rates the monetary policies of most nations were governed by the stable monetary policy of the United States. In the 1970's, the dollar standard was reduced to a weak form where industrial (but not less-developed) countries float their exchange rates to secure more domestic monetary independence, but the financial processes underlying international trade itself remain dollar based. What are the elements of the weak dollar standard necessary for world trade to remain largely monetized and multilateral? How can nations avoid a relapse to the bilateralism and barter that characterized the 1930's? I shall consider first, necessary restraints on foreign exchange intervention and reserve holdings by central banks of industrial economies other than the United States; and second, the proper American monetary policy for reconciling the weakened international role of the dollar with domestic monetary stability.