Neither a Borrower Nor a Lender Be . . .

James Fallows has a very good Atlantic Monthly article on the peculiar financial relationship that has arisen between China and the United States. Americans spend everything they make and save nothing, lately, but the far poorer Chinese consume only about half of what they produce.

This is not solely or mainly due to the special virtue of the Chinese or the recklessness of individual Americans but to the policies of their governments. China is still an authoritarian state, and it uses government power to keep most of the wealth its rapid growth is producing out of the hands of the people. Under George Bush and the Republicans, the American government has spent recklessly while borrowing immense amounts from abroad. Meanwhile, the lax regulations and misguided ideology of Bush and Greenspan encouraged similarly reckless behavior by American banks and consumers.

It is a very unnatural event for the world's richest nation to be the world's biggest debtor, but that's what has happened. Smaller and poorer nations routinely make the mistake of living beyond their means and the consequences are usually dire.

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China. Like so many imbalances in economics, this one can’t go on indefinitely, and therefore won’t. But the way it ends—suddenly versus gradually, for predictable reasons versus during a panic—will make an enormous difference to the U.S. and Chinese economies over the next few years, to say nothing of bystanders in Europe and elsewhere.

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

The Chinese government no doubt has its own reasons, but central to them must be the desire to keep going the growth that has made them a great industrial power even while US industry declines and withers. It's hard to explain the American governments actions except in terms of the stupidity and venality of Bush and his allies.

China is our biggest creditor, but far from the only one. The Gulf states, Japan, Russia, and India are owed big pieces of our hide as well.

For now, the US has one vital advantage over the ordinary person who owes the bank a fortune: it controls the currency in which the debts are denominated, and can, if necessary, print the money to pay them. That's another scenario with a history of ending badly, but it's one that Bernanke has already been forced to dabble in.

For the moment all parties to this arrangement are stuck in the rut of a "balance of financial terror." Those who might want to cut loose from the dollar dare not for fear that their attempt will trigger a collapse in value of their dollar assets. With the dollar already in slow motion free fall, their assets are already losing a lot of value, and it probably takes only one big player's panic to bring the whole thing down.

No one can clearly see how this will all end, but it seems increasingly likely that Americans are going to get a whole lot poorer.