Geithner: substantial accumulation of dollar reserves mask impact of deficits …

Tim Geithner:

"Part of this recent dynamic in financial markets is a consequence of the present state of the international monetary system, in which a substantial part of the world economy runs exchange rate regimes tied in some way to the dollar. This has entailed a sustained period of very substantial official accumulation of dollar reserves, putting downward pressure on U.S. interest rates and upward pressure on U.S. asset prices.

These forces are surely transitory, but their impact on capital flows, interest rates and asset prices are important, not just in terms of their short-term impact on growth. If they are large enough, they have the potential to alter or distort current decisions about investment and consumption in a way that could be detrimental to our longer-run growth prospects. And they are important because they work to mask or dampen the effects on risk premiums in financial markets that we might otherwise expect to be associated with the expected trajectory of the fiscal and external imbalances in the United States."

I worked for Geithner at the Treasury and the IMF, so perhaps it isn't a real surprise that I deeply agree.  Official flows also help to explain why the US attracts the lion's share of (net) cross-border capital flows, even though returns in US markets have lagged returns in most other markets.   That is why the rumblings coming out of the Gulf -- and any real change in Chinese policy, however unlikely, could matter.