Larry Summers has always believed that capital should flow from the already rich and aging societies that constitute the current core of the world economy to the poor and young countries on the periphery.   So it is not entirely a surprise that Summers thinks "the most surprising development in the international financial system over the last half a dozen years" is "the large flow of capital from the world's most successful emerging markets to the traditional industrial countries, and the associated build-up of reserves in the developing world." 

Summers notes that this surge in reserves was neither predicted nor predictable.  I would add, though, that Dooley, Garber and Folkerts-Landau noticed it more quickly than most, and certainly predicted back in 2003 that large-scale reserve accumulation would be sustained.   So far, they have been right.

Robert Hodrick of Columbia argues (through Daniel Altman's Economic View Column ) that "The U.S. capital markets are where people want to invest their money right now and the performance of our economy has been really extraordinary, so there's no reason to think that's a bad idea." 

Actually, the US is where central banks want to invest their money right now.  

Summers, citing work that Sangeetha Ramaswamy and I have done, notes that foreign central banks added $670b to their reserves in 2005.   That probably understates the real growth in all official assets.  It includes the entire expansion of the foreign balance sheet of the Saudi Monetary Authority.  But not any increase in the al-Saud family's personal assets, or, more importantly, any new funds that have been contributed to the Kuwait, Abu Dhabi and similar investment authorities.   Pick the fraction of $670 b plus that you think flowed into the US.  I am pretty sure it is far more than the $220b or so in official inflows that showed up in the US data.

Summers also doesn't think emerging market central banks investment in the US is all that good an idea, at least financially.   Remember, foreigners who bought dollars in say 2001 have not done so well in the world's greatest place to invest.  Talk to a few Europeans ...  or read Philip Lane and Gian-Maria Milesi-Ferretti.   Summers thinks emerging markets central banks will get a negative real return on their current investments in the US - as low real US rates fail to compensate them for the risk of a real depreciation against the dollar.

"[the] flow of capital from emerging markets to industrial countries, huge accumulation of reserves and expected negative returns on reserves constitute what might be called the capital flows paradox in the current world financial system."

The headline from Summers speech was "central banks shouldn't be so keen on holding Treasuries."   

Perhaps more importantly though, Summers also suggested that the time has come to start to reconceptualize the role of the international financial institutions.