The Gulf's decision to stick to its dollar peg is harder to understand. The Gulf doesn't have to worry about competition from China in the oil market. A move away from the dollar likely would increase the Gulf's own monetary stability-as pegging to a depreciating currency even as oil has soared has predictably meant a destabilizing rise in inflation. Saudi inflation recently topped 8 percent-and that is well below the inflation rate in the rest of the Gulf.

Leverett offers a simple explanation for the Gulf's continued willingness to peg to the dollar: the Saudis view their dollar peg-and dollar pricing of oil-as a central component of their strategic alliance with the United States. The Saudis' reluctance to move, in turn, has shaped the choices of the other Gulf states-who have to consider the impact of any unilateral move on the Gulf's plans for a currency union and their relations with the Gulf Cooperation Council's (GCC) own dominant power. This argument cannot be pushed too far: Kuwait has an even-closer strategic relationship with the United States than the Saudis, but it nonetheless made a small step away from a pure dollar peg in May 2007. But it no doubt helps to explain why the GCC has remained pegged to the dollar, despite the growing economic costs of the dollar peg.

At some point, though, rising inflation will begin to threaten the domestic stability of key Gulf states. A desire not to sacrifice domestic economic stability-and ultimately domestic political stability-for the dollar peg could change the Saudis' strategic calculations. Nor would the strategic consequences of ending the Gulf's peg to the dollar be altogether dire: the United States' strategic commitment to the Gulf stems from the Gulf's oil, not its willingness to hold dollar assets.

The conflicting economic and political interests of the two poles of the axis of oil likely limit the scope for "West" and "East" Asia to cooperate to "balance" American power. However, this shouldn't be a great source of comfort to the United States. The enormous rise in the financial assets in the hands of the Gulf's ruling families and China's government means that they do not necessarily need to cooperate to be in a position to try to influence U.S. policy. China ended 2007 with $1.5 trillion in reserves-a total that rises to $1.7-$1.8 trillion after counting the foreign assets of the state banks and the China Investment Corporation. The Gulf's total assets are a bit harder to add up. The size of two of the largest pools of funds in the Gulf (the portfolio of the Abu Dhabi Investment Authority and the "private" assets of leading Saudi families) hasn't been disclosed. However, a reasonable estimate would put the combined assets of the governments of the Gulf states at around $1.5 trillion and the Gulf's total assets at close to $2 trillion. A major portfolio shift by either China or the big Gulf states would roil global markets.

Indeed, China could cause widespread disruption without selling a single dollar: all it would need to do is to stop adding to its dollar portfolio. China's foreign assets (counting the assets of the state banks) increased by at least $500 billion in 2007-and are increasing at an even-faster pace in the first part of 2008. Maintaining a constant 70 percent dollar share of its portfolio consequently requires that China add several hundred billion to its dollar holdings every year. If that flow stopped, the United States likely would have trouble sustaining its roughly $750 billion current-account deficit. The buildup of the Gulf's dollar assets is also quite impressive, but even with oil at $100 a barrel, the Gulf won't be providing the United States with quite as much financing as China.

These flows have strategic consequences. It is hard-to paraphrase Senator Hillary Clinton (D-NY)-to push for political change in your bankers. This is especially the case when large American financial institutions have turned to the sovereign funds of many nondemocratic governments for emergency capital. There is a good chance that greater democratization in these states might reduce the willingness of their central banks and government funds to supply as much financing to the United States. Governments in China and the Gulf that were more accountable to their citizenry would face increasing pressure to devote more resources to their internal development. A more-democratic and more-transparent Gulf would almost certainly supply less fee income to U.S. and European investment banks, hedge funds and private-equity firms.

The growing financial clout of these nondemocratic governments also constrains the United States' policy options. It, for example, implies that a concert of democracies cannot serve as the basis for global economic governance. An effective coalition for collaboratively addressing the structural imbalances in the global economy now has to include nondemocratic governments.

But does this mean that the United States needs to change or alter its policies to better accommodate the desires of its creditors? Not necessarily. Washington could engage in a game of high-stakes financial and strategic chicken: rather than seeking a strategic accommodation with its creditors that would minimize their incentives to try to balance the United States, the United States would continue to adopt policies that reflect its own perception of its interests and dare its creditors to try to translate their potential financial power into actual leverage.

America's creditors cannot stop financing the United States without incurring domestic costs, costs that they may be unwilling to bear even to secure strategic gains. Less Chinese financing for the United States would mean less U.S. demand for Chinese products-and more Chinese purchases of European assets wouldn't endear China to Europe either. China didn't vote with the United States on the UN resolution authorizing the Iraq War. That didn't prevent the People's Bank of China from buying the treasuries the United States issued to finance that war.

Such an approach runs the risk of a misunderstanding that might lead to a collapse of what former-Treasury Secretary Lawrence Summers called the balance of financial terror. It consequently sounds a bit reckless. But it has some loose parallels with the approach that the United States has adopted toward the financial interests of its creditors. Concerns about the value of the dollar haven't prevented the United States from cutting domestic U.S. interest rates to try to stimulate the economy. Concerns about the United States' rising external debts have not prevented Washington from adopting an aggressive program of fiscal stimulus-a stimulus that likely will be financed in large part by the sale of government bonds to China's central bank and the Saudi Arabian Monetary Agency. China and others might prefer that the United States adopt a set of policies that protected the value of the dollar-and thus protected the value of their dollar-denominated financial claims. But until they insist, the United States retains full freedom of action.

Coordinated action by a new "axis of oil" is unlikely. This though shouldn't give U.S. policy makers too much comfort: the United States' big creditors don't really need to coordinate in order to be in position to try to turn their financial clout into strategic leverage. China now is a big enough player in global financial markets to have substantial leverage even if it acts on its own. The main constraint on China is the difficulty of abandoning the domestic constituencies that benefit from its currency policy of adding dollars to its portfolio no matter what the United States does. But as the domestic costs of China's current policy rise, China's own calculation of its interest may also begin to change.

Brad Setser is a fellow for geoeconomics at the Council on Foreign Relations.

¹The precise currency composition of China's reserves and the Gulf Cooperation Council (GCC) countries' reserves is a state secret. Nonetheless, U.S. data suggest that China continues to keep most of its reserves in dollars. The Gulf sovereign funds seem to have diversified away from the dollar, but their efforts have been offset by the enormous recent increase in the central-bank reserves of the GCC countries. The limited available evidence suggests that most of these reserves remain in dollars.

²The Gulf's sovereign funds likely have reduced the share of their rapidly growing portfolios held in dollars. However, this shift has coincided with a surge in speculative pressure on the Gulf currencies, pressure that has led to an enormous increase in central-bank-reserve growth. As a result, the Gulf economies likely have not diversified away from the dollar. See Brad Setser and Rachel Ziemba, "Understanding the New Financial Superpower-The Management of GCC Official Foreign Assets" (New York: RGE Monitor, December 2007).