Nouriel Roubini has an excellent, and typically sobering piece on what he sees as the denouement of what he calls Bretton Woods 2, the system we have of less than floating exchange rates (i.e., many East Asian countries + the Gulf States maintain hard pegs; China has a dirty float).
Conventional wisdom has been that at some point rising inflation would force these countries to break their pegs (the inflation is due to considerable degree to the inability to fully sterilize the purchases of dollars they must make to keep the value of their currencies in line with the greenback).
However, Roubini, who has been prescient on this topic, sees another outcome: with world growth and demand looking wobbly, these countries (which are not the most politically stable, an important fact to keep in mind) are reluctant to risk a big slowdown or huge damage to exporters by letting their currencies appreciate.
Roubini believes they will let inflation run, and even allow it to become embedded. In the long run, this will achieve similar results to a revaluation (as local goods prices rise in nominal terms, it winds up increasing the price of exports, much as currency appreciation would. However, it would happen more gradually and (implicit in Roubini’s argument) it would be hard to point fingers (while a change in the currency regime would clearly be tied to specific authorities).
While Roubini may well be correct, that many countries will follow the path of least resistance, the consequences of this development would be profound. Highly inflationary economies are terrible for financial investment (I recall that the 24 stocks traded on Mexico’s Bolsa in 1984 had P/Es of either 2 or 4), indeed, investment of any kind.
Similarly, in the stone ages of my youth, currencies that offered investments with high interest rates were shunned. The assumption was that they were fundamentally unsound and prone to devaluation. The bad image of high inflation economies carried over to moderate inflation ones, the reverse of the yield-chasing carry trade logic of today. Although one robin does not make a spring, India is now apparently having to defend its currency from a fall, the converse of what one would have expected a year ago.
Roubini’s post is very much worth your attention. Aside from a thoughtful discussion of our current situation, it makes illuminating comparisons to the breakdown of Bretton Woods 1.
Peripheral Visionary 
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How long the dollar-peg policies of East Asia and the Gulf will continue is anybody’s guess. But they certainly help explain, during this decade, the ongoing official purchases of dollars which have ballooned the Fed’s off-balance-sheet custody account into a brobdingnagian $2.3 trillion slush fund.
These purchases imply that the dollar — weak as it may be versus euros and yen — has been systematically overvalued, while U.S. interest rates correspondingly were held artificially low. This configuration in itself implies malinvestment. For instance, a systematically overvalued currency doesn’t lend itself to being a manufacturing platform. And indeed, U.S. manufacturing has been in freefall.
Meanwhile, depressed real rates of interest tend to induce asset speculation. Check — we sure got plenty of that. Of course, these same tendencies will occur in local currencies which mirror the dollar. The out-of-control building boom in the Gulf states is a prime example.
How does it all fail? The question is finding the weak link. Any gigantic pool of liquid funds is inherently risky, because its owners can seek to redeem it. The Fed’s custody account is nearly 2.5 times the size of its balance sheet, which is itself levered on a thin slice of equity. A sudden redemption call on the Fed’s custody account could send rates skying. That’s one possible mode of Bretton Woods II failure. Doubtless there are others.
CONfidence is everything, Ben. Don’t let central bankers in bowler hats line up outside the Eccles Building — it could cause panic!