China's dollar problem: the limits to eternal greenback accumulation.

• Author: Rogoff, Kenneth

When will China finally realize that it cannot accumulate dollars forever? It already has more than $2 trillion. Do the Chinese really want to be sitting on $4 trillion in another five to ten years? With the United States 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 from 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 costs of waging the Vietnam War and a surge in oil prices ultimately contributed to a calamitous rise in inflation.

Perhaps the Chinese should not worry. After all, the world leaders who just gathered at the G20 summit in Pittsburgh said that 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 trade 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 build-up of the crisis. Cheap money from abroad juiced an already fragile financial regulatory and supervisory structure that needed discipline more than cash.

Unfortunately, we have heard leaders--especially from the United States--claim before that they recognized the problem. In the run-up to the financial crisis, the U.S. external deficit was soaking up almost 70 percent of the excess funds saved by China, Japan, Germany, Russia, Saudi Arabia, and all the countries with current account surpluses combined. But, rather than taking significant action, the United States continued to grease the wheels of its financial sector. Europeans, who were called on to improve productivity and raise domestic demand, reformed their economies at a glacial pace, while China maintained its export-led growth strategy.

It took the financial crisis to put the brakes on U.S. borrowing train--America's current account deficit has now shrunk to just 3 percent of its annual income, compared to nearly 7 percent a few years ago. But will Americans' newfound...