It is now essential for China to take the leadership role in the global economy, otherwise the world may truly face a horrific depression. Calls for a new global reserve currency are wrong-headed. Though that may eventually be the consequence, it won't happen just because it has been ordained by a group of Finance Ministers or Central Bankers. The real issue is how China manages the unwinding process of its IOU's (US Dollars), which should be for real goods, not some other paper currency issued by a different Government.
Since at least the 1940's and perhaps earlier, the US has always been both the engine of global growth and the foundation of the financial system. Most recently, the US consumer has been the magnet attracting exports from China and the other developing nations, who have been happily accepting dollars in return. By their continued actions, it is clear that the US and China put their faith in the notion that those IOU's would continue to hold their value till the time would come when China would eventually cash them in.
As long as US consumers continued to import from abroad, Chinese exporters sent their wares to US shores and the Fed financed all these transactions by providing a steady supply of US Dollars, everyone was happy. This resulted in massive current account and trade deficits in the US, but did not harm the real economy until the financial system collapsed last Fall.
The perscription for the financial crisis was an absolute massive increase in the supply of the IOU's, and now China is predictably worried about whether they will receive full value for the more than $1 Trillion they are holding. Therefore, China will not choose to sell those dollars in favor of other currencies as doing so would catastrophically kill the nation's wealth.
Instead, the world requires China to turn its economy inward and fire up a domestic engine of growth much as the US did through the second half of the 20th century, so that all the accumulated dollars can be used to purchase US-priced goods, services and assets.
The other side of this coin, is that the US must quickly get on the path of repairing credibility in the US Dollar or China's actions won't matter. Though China may hold enormous power due to its US Dollar holdings, international investors and currency traders can quicly launch an assault on the Dollar if they smell blood, ushering in destructive inflation that will take at least a generation to deal with. To prevent this, the US must face reality and curtail spending right away.
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