Unfortunately one of the few things still made in America is inflation. In fact, it now ranks as our greatest export.

A significant by-product of the current global economic system, wherein Americans spend money they do not earn to buy foreign products that they do not make, is that trillions of dollars are now parked in foreign banks just looking for somewhere to go.

In a healthy trade relationship, a nation pays for its imports with equal exports that result from real productivity that pumps up demand. In contrast, the current U.S. import boom has been created by the artificial demand of inflation, in which increased money supply has put more dollars in the hands of U.S. consumers. Normally, such growth in money supply would result in more substantial increases in domestic consumer prices. However for a number of reasons, the United States has been able to partially dodge this bullet. In short, we have exported our inflation abroad.

Our foreign creditors basically have two choices as how to dispose of their excess dollars. They can use them to buy U.S. financial assets, such as bonds, stocks or real estate, or they can exchange them for other currencies or commodities, such as gold or oil. If they choose the former, foreign central banks are off the hook, as those dollars find their way back to the U.S. economy without any additional money creation. However, as foreigners are increasingly choosing the latter, foreign central banks have been "forced" to print money like it's going out of style.

In years past, foreign investors were happy to hold strong U.S. dollars, which they either saved as a store of value, or used to purchase mighty Wall Street stocks and bonds. However, when the dollar began its epic swan dive, and U.S. investments began to grossly underperform non-U.S. alternatives, private investors dumped their dollars en masse by exchanging them for local currencies. The unwanted dollars then became the property and problem of foreign central banks.

If central banks did not buy these dollars, foreign citizens would have been forced to sell their surplus dollars on the open market. To prevent this from happening these banks have become the buyers of first and last resort. However, to sop up all of the excess supply, central banks must create more of their own, resulting in rapidly expanding money supplies. As much as Wall Street and government economists pretend otherwise, the expansion of money supply is the essential definition of inflation. The real reason that prices are rising in China is that so many yuan are being printed to buy up all these surplus dollars.

For much of the past decade foreign central banks invested their swelling U.S. dollar reserves in U.S. debt instruments, such as treasuries and mortgage backed securities. Not incidentally, these purchases helped sustain our housing and credit bubbles. But as a result of increasingly poor returns, sovereign wealth funds have recently been created to buy tangible assets instead, such as large portions of Merrill Lynch and Morgan Stanley. Thus far these investments have performed poorly (note the 50% decline in the value of the China's stake in Blackstone). However, my guess is that such losses are of little concern, as the Chinese understand that any active use of their dollars, regardless of short-term performance, is seen as a positive because ultimately their unused dollars might be practically worthless!

It is no accident that those regions experiencing the highest inflation are those with currencies pegged to the dollar. The formerly strong dollar provided a compelling rationale for nations with weaker currencies to maintain currency pegs. The linkage provided badly needed discipline to their central banks and created confidence in their currencies. However, it makes no sense at all for a nation with a strong currency to peg to a weaker one. It is analogous to an honor student cheating on his exam by copying the answers from the worst student in the class.

Many economic analysts have noted that rising prices in China are now resulting in higher import prices for Americans. Ironically, many have concluded that this is evidence of China exporting inflation to the U.S. rather than China merely returning the inflation to its original source.

Initially, the strong productivity growth of these export nations worked to lower consumer prices and masked the inflationary impact of rapid money supply growth. However, with prices now exploding throughout Asia and the Middle East, governments can no longer ignore the inflation problem. China has recently imposed price controls to deal with rapid increases in consumer prices. However, as this merely attempts to mask the symptoms of inflation rather than addressing its root cause, this policy will prove as ineffective as it did in the United States in the 1970's. Once all of these misguided cures fail, Asia and the Gulf nations will swallow the only medicine that will work. They will completely pull the plug on their dollar pegs. When they do it will not just be the dollar, but the entire American economy that goes down the drain.

The manner in which this massive bundle of funds will be disposed will have a gargantuan impact on the trajectory of the world economy. Unfortunately for America, the decisions are out of our hands, but the ramifications will largely be ours to bear.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read my new book "Crash Proof: How to Profit from the Coming Economic Collapse."