When will China finally realize that it cannot accumulate U.S. dollars forever? It already has more than $2-trillion. Do the Chinese really want to be sitting on $4-trillion in five to 10 years? With the U.S. government staring at the long-term costs of the financial bailout, as well as inexorably rising entitlement costs, shouldn't the Chinese worry about a repeat of Europe's experience in the 1970s?
During the 1950s and 1960s, Europeans amassed a huge stash of U.S. Treasury bills in an effort to maintain fixed exchange-rate pegs, much as China has done today. Unfortunately, the purchasing power of Europe's dollars shrivelled during the 1970s, when the cost of waging the Vietnam War and a surge in oil prices ultimately contributed to a calamitous rise in inflation.
But perhaps the Chinese should not worry. After all, the world leaders who just gathered at the G20 summit in Pittsburgh said they would take every measure to prevent such a thing from happening again. A key pillar of their prevention strategy is to scale back “global imbalances,” a euphemism for the huge U.S. trade deficit and the corresponding surpluses elsewhere, not least China.
The fact that world leaders recognize that global imbalances are a huge problem is welcome news. Many economists, including myself, believe that America's thirst for foreign capital to finance its consumption binge played a critical role in the buildup of the economic crisis. Cheap money from abroad juiced an already fragile financial regulatory and supervisory structure that needed discipline more than it needed cash.
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