I expect that the US/China trade balance will shrink (we must have seen the high water mark and an average of say 40% of the current level looks probable, unless the US experiences another iffy boom) and that financial revenue from the accumulated reserves will be extremely modest. But it will still be quite a lot. Pity China’s neighbours though…

Freitas — I haven’t looked closely at the stiglitz proposals. I probably should. I tend though to be suspicious of calls for a new global currency or global reserve currency, as I don’t see the US giving up the dollar, europe giving up the euro, britain giving up the pound and so on. I am though inclined to think that over time an asian reserve currency will develop, and that if the asian reserve currency floats against the dollar and euro, that wouldn’t be a bad outcome for the uS (or the world). The existing world financial order – where much of asia and the gulf peg their currencies to the dollar, smaller european currencies manage their currencies v the euro (in general) and the euro and dollar float against each other — hasn’t necessarily worked all that well.

michael — the suppliers of the reserve currency haven’t necessarily been debtors running trade deficits. the us ran surplus in the 50s and 60s. and britain generally speaking ran a surplus too. a debtor as a reserve currency poses some risks to the holder of the reserves – risks that countries piling up dollar claims to support their export sectors have opted to ignore.

I agree though that for China to supply asia with a reserve currency, it either has to:

a) run trade deficits that allow asian countries to accumulate rmb claims on china (and allow Asian countries to hold rmb as part of their reserves)

b)or lend rmb to a host of asian countries — rmb that the countries would then lend back to china by holding s-term rmb paper. basically, long-term inflows (debt or equity) from china would be recycled back into s-term rmb claims held as reserves. that implies these inflows could not be used to support trade deficits.

or china could sell some rmb to countries for their dollars, absorbing the rest of asia’s dollars while supplying asia with rmb. that though increases china’s dollar risk — as it is taking an inflow into rmb debt from the rest of asia and using it to increase its already substantial dollar holdings.

china has sought to get around this with swaps — effectively promising countries that they can exchange their currencies for rmb if they need rmb. that avoids the need to hold physical rmb — and thus the need for china to absorb inflows. it isn’t clear though that it will work. for their reserves, countries typically want actual asset — not just a promise to deliver fx if needed. swap lines aren’t always renewed in a crisis — they aren’t a full substitute for reserves.

the us is a bit of an exception; it effectively relies on its ability to swap $ for euros — but the us and the key european countries are tied together in a true security alliance as well as in a host of economic institutions. China’s relationship with the rest of asia is somewhat different.

Thailand incidentally currently has a non-trivial portion of euros other non-dollar currencies in its reserves.

Right, knowing all Chinese is beyond even your considerable powers but knowing what those in power want is not. I am impressed. Although it is of course not too hard to guess. China appears to derive long term benefits from the IR status quo (who would not be grateful for a US president who shares that preference, see the rather meek and routine references to US humanistic hobbyhorses whilst the message of a Chinese speaking representative is very strong (and that next to a Treasury Secretary who has Chinese too!) and it appears likely that China’s view of a cooperative situation would be maintenance (some harmless rhetoric for domestic consumption included) of the status quo of a very high degree of complementarity rather than competition. China goes on expanding its sphere of economic interest in terrae nullius (from a US perspective) like Sudan, Congo etc, and life for the US in its self-dug Islamic hole is not complicated by a long term resident player in Central Asia like China. And, as usual, the economy will take care of itself. US stimulus is good for US employment, hence consumption, hence Chinese exports, hence stability in Beijing/pricincial relations and urban affairs. Meanwhile Chinese domestic stimulus is good for expanding modernity without antagonizing urban citizens and “taxpayers”. It would be utterly foolish to upset this by childish territorial ambitions. When are we going to accept that what we have got is likely to persist for quite a while: China will continue to manipulate its currency, but restrict itself to risk-free (and low return) warehousing of the cumulative BOP surplus. It will continue to tease about agencies etc but not throw good money after bad. Officials tend to be risk averse, so no one will be trying to build a career out of financial market risk taking (certainly not after the CITIC affair).

And, with rising standards of living in China plus a decade of declining ones in the US, the wage gap may become so manageable (one China achieves rough technological parity or at least productivity growth tapers off) that BWII goes on forever. I never thought that freely floating FX rates were either feasible in the long term, or desirable if one takes into account strategic interest group behaviour in an international context. You do not have to be Chinese to be a realist.

I wonder what you would say about the possibility of a global reserve system instead of those ad hoc, nationally based, transitory (un)balances. Do you consider any kind of multilateral arrangement politically feasible? Would it make sense in economic terms? What other conditions (capital controls, punishment on deficit and surplus countries, governance issues, interest rates on the global reserve) do you think it would be needed? Or dont you even consider this possibility? Have you seen Stiglitz UN Comission`s proposal on that?

Many questions, I know. But you are the one I would like to hear about that.

Thanks!