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The Effect of the Crisis on the U.S.-China Economic Relationship
China's Economy, China, Global Economics, Global Financial Crisis, U.S. Economy
Eswar Prasad, Senior Fellow, Global Economy and Development
U.S.-China Economic and Security Review Commission
Feb 17/2009
Whatever one’s view about the centrality of these imbalances versus problems in the U.S. financial system in triggering the crisis, there is no doubt that global imbalances allowed problems in the U.S. financial system to fester and end in a cataclysm. More importantly, the underlying policies that generated those imbalances were clearly not in the long-term interests of the countries concerned themselves. A looming problem is that these imbalances could actually worsen over the short term, perpetuating macroeconomic problems in the main economies and possibly setting the stage for the global economy to take another tumble in the future.

"The US is the ultimate financial safe haven, with the flight to quality around the world turning into a flight to U.S. treasury bonds."

Indeed, there is a rich set of ironies in the way the crisis has played out. First, the global macro imbalances are not unraveling in the way that most economists had expected. Rather than adjusting via a decline in the external value of the dollar, the U.S. current account deficit may apparently adjust with just a massive contraction in private consumption.[4] Second, the U.S., which has been at the epicenter of the crisis, has become the ultimate financial safe haven, with the flight to quality around the world turning into a flight to U.S. treasury bonds. Third, and most worryingly, the rest of the world still seems to be counting on the U.S. as a demander of last resort. Fourth, all signs are that the global crisis may lead to emerging markets rethinking old notions of reserve adequacy and consider building up even larger stocks of reserves.