It is often said that when America sneezes, the world catches cold. This adage is a modern adaptation of the 19th century saying—attributed to Prince Klemens von Metternich—that, “When Paris sneezes, Europe catches cold.” Today, economic developments in China have obvious repercussions across borders as well, affecting everyone from small emerging economies to Europe and the United States. We live in a world where our economic fates are increasingly intertwined. Indeed, Metternich’s saying is now often heard with China as the proverbial sneezer.

For the moment, emerging Asia is offsetting weakness in external demand through accommodative monetary and fiscal policies. But ultimately, it would be desirable, both for the region and for the global economy, if emerging Asia were able to rely less on temporary policy stimulus and more on a fundamental rebalancing of growth toward domestic demand.

“We face a very real risk of having formidable competitors to the dollar in the sweepstakes for sovereign investment,” Fisher said today in remarks prepared for a speech in La Jolla, California. “As Chinese policy makers lay the groundwork for the continued internationalization of the renminbi, our nation’s fiscal authorities must bear in mind that there may one day be viable alternatives to the dollar and U.S. Treasury debt.”

"Inflation has been a threat especially for countries with quasi-fixed exchange rates with the dollar," Bullard noted, without mentioning specific countries.

[T]he current international monetary system is a mixture of economies, some with open capital accounts and flexible exchange rates, and others with managed exchange rates, more-restricted capital mobility, and more-limited monetary policy independence. Many of these latter economies also have current account surpluses, in part because authorities have been able to resist currency appreciation, and thus inhibit external adjustment, for prolonged periods. This feature of the international system inhibits the process of global rebalancing and could restrain the current recovery.

Too often the questions asked are: What is most beneficial to the banks of my particular country? Do the regulations bolster or harm my "national champion"? The focus shifts away from the goal of bolstering global financial stability to finding ways of tilting or adjusting the new standards to achieve a national competitive advantage.

This is in not in anyone's interest. As discussed earlier, every nation has an interest in promoting financial stability globally, since the effects of systemic financial stress in one place can swiftly spread throughout the global economy. Moreover, although a relatively loose regulatory regime may attract business from other financial centers, there is no free lunch here. A more lax regulatory regime is likely to expose that country’s taxpayers to huge tail risks.

We need a system characterized by more open capital accounts, flexible exchange rates, and independent monetary policies. Open capital accounts, supported by appropriate financial supervision and regulation, channel savings to their most productive uses, thereby enhancing welfare. Exchange rate flexibility improves domestic macroeconomic management, allowing countries to pursue independent monetary policies tailored to their individual needs, and limits unwelcome spillovers to other economies. Such a system can also flexibly adapt to changing economic and financial realities as countries develop, technology progresses, and shocks buffet the global economy.

Our current international monetary system does not yet fulfill these objectives.

Notably, in recent months, some officials in emerging market economies and elsewhere have argued that accommodative monetary policies in the advanced economies, especially the United States, have been producing negative spillover effects on their economies. In particular, they are concerned that advanced economy policies are inducing excessive capital inflows to the emerging market economies, inflows that in turn put unwelcome upward pressure on emerging market currencies and threaten to create asset price bubbles...

To a large degree, these capital flows have been driven by perceived return differentials that favor emerging markets, resulting from factors such as stronger expected growth--both in the short term and in the longer run--and higher interest rates, which reflect differences in policy settings as well as other forces....

Given these advantages of a system of market-determined exchange rates, why have officials in many emerging markets leaned against appreciation of their currencies toward levels more consistent with market fundamentals? The principal answer is that currency undervaluation on the part of some countries has been part of a long-term export-led strategy for growth and development. This strategy, which allows a country's producers to operate at a greater scale and to produce a more diverse set of products than domestic demand alone might sustain, has been viewed as promoting economic growth and, more broadly, as making an important contribution to the development of a number of countries. However, increasingly over time, the strategy of currency undervaluation has demonstrated important drawbacks, both for the world system and for the countries using that strategy.

In response to a question about U.S. negotiating leverage with China.

Well, they have their own views and interests, that we don't always agree with them, certainly. But they are very interested in what the United States is doing and thinking. They understand there's a kind of co-dependency relationship, and they certainly want to engage with us.

Now, obviously, we're not going to be happy with every outcome and certainly we're not. There are lots of issues that we are currently debating with them. But all I'm saying here is that there is a real desire on both sides to engage, and that for me that is a very important achievement to have those lines of communication be open.

For some economies, a rebalancing of demand toward domestic sectors will require significant changes in relative prices, and hence more flexible exchange rates will need to be part of the equation. These measures will not be undertaken solely to satisfy the ethereal principle of global rebalancing enunciated at countless meetings in international policy circles; instead, these measures will be undertaken because they are in the best interests of the countries themselves. In particular, more flexible exchange rates will help domestic demand fill in the gap left once foreign demand falls back to a more sustainable level. More flexible exchange rates also provide domestic policymakers greater scope to focus on domestic goals of full employment and price stability.

I don't see the Chinese doing anything that would damage the United States. It's in their interest - and in a way they're in bed with us as investors and savers.

Globalization does matter for inflation, but not in the ways that are often suggested in the media. The most common fallacy is, of course, the confusion of relative price with price level changes, the idea that a flood of cheap imports from China must of necessity lower the price level and the inflation rate. The channels whereby globalization affects inflation are much more subtle and not always necessarily benign. Furthermore, I believe that different dimensions of globalization affect the dynamics of inflation in fundamentally different ways.

Let’s start with trade. The availability of cheap imports from China and other countries does have a direct and indirect impact on domestic prices and inflation. There has been a significant amount of work in recent years trying to document the size of this effect. The estimates vary, but they are generally significant. But the mechanism whereby the price changes are realized is subtle.

... I'm not particularly concerned about any major change in the holdings of China or any other country.

There is, on the margin, sovereign wealth funds and portions of reserve accumulations that are being devoted to higher return, which means spreading across instruments, as well as across currencies.

But again, I don't see any significant change in the broad holdings of dollars around the country -- around the world.  Dollars remains the dominant reserve asset and I expect that to continue to be the case.

I would like to add, though, that the strength of the dollar, in the medium term, will ultimately depend not on those portfolio choices, so much as on the strength of the U.S. economy, our trade situation and on the openness of our financial markets to foreign capital.

And I'm optimistic on those fronts. And I do believe that that will lead to a sound dollar in the medium term.

London, Hong Kong, Singapore, and Shanghai increasingly seek to challenge New York as the center of global financial markets. Competitive national ambitions, perhaps, have demanded an embrace of economic liberalism to build wealth even among those regimes that may prefer something closer to autocracy in their non-economic dealings.

Beginning in July 2005, the Chinese government officially unpegged the RMB from the dollar, and, since then, the currency has appreciated by about 6%.  Chinese policymakers seem likely to allow this process of gradual RMB appreciation to continue, so long as it is slow and orderly.  Few people, however, believe that even a more substantial RMB appreciation would have much effect on China's overall trade balance. F or one thing, to the extent that China imports many components used in producing its export goods, an appreciation lowers the cost of those imports, offsetting somewhat the effect on export prices.  For another, demand for many Chinese exports tends to be fairly strong, regardless of price, which implies a limited trade response to an appreciation.  Most observers do not see China's trade surplus coming down until it ramps up government spending and domestic consumption, increasing its own demand for foreign imports.

To exert some control on slow and orderly movements in the RMB, the PBOC intervenes in the foreign exchange market, buying dollars with RMB that it issues. This intervention has resulted in the PBOC's accumulation of over $1 trillion in foreign reserve assets. Moreover, such intervention also swells the domestic supply of bank reserves. Therefore, to avoid inflation, the PBOC must offset the associated liquidity increase by sterilizing reserve inflows. It has accomplished this by issuing low-yield PBOC bills in open market operations and by progressively raising the reserve requirements of domestic banks. However, the policy of forcing low-yield PBOC bills on the banking sector works at cross-purposes with banking sector reforms, which are ultimately aimed at creating a banking sector that operates on a sound commercial basis.