America owes China two trillion dollars. But what does that mean?

There are one or two issues of major global importance which get too little attention, simply because they are so complex. One of them is the uncomfortable economic stand-off between China and America, about which learned articles have rumbled on for months in the stiffer journals, read by few and understood by even fewer. Now they are snapping at each other about little bits of protectionism, but that’s just the tip of the iceberg.

We are all familiar with the aphorism which goes: “If you owe someone a thousand pounds, you’ve got a problem. If you owe someone a million pounds, he’s got a problem.” Now, the US owes China two trillion dollars. Who’s got the problem?

In an earlier blogpost I flippantly suggested that if the US’s debt to China got any bigger China would in effect “own” the USA. Of course this is nonsense, because China has no way of staking its claim. Should the US default on a payment, they can hardly send the bailiffs round to repossess California. Every now and then the Chinese mutter about the possibility of doing down the dollar by changing some of their reserves into yen or euros, but they don’t mean it: they don’t want to undermine the dollar while they’re still owed so many of them.

Meanwhile, the Americans grumble endlessly that the Chinese are keeping the value of their currency artificially low. It is a logical nonsense that one of the world economy’s biggest players still has a currency which is not freely convertible and allowed to find its own level on the markets. But it’s not exactly hard to see why the Chinese are not yet prepared to venture forth on the choppy waters of untrammelled currency speculation. Their current policy originated as a defence against the worst of the Asian financial crisis in the late 90s, and its wisdom wasn’t exactly shaken by more recent events.

So, to the American plea to level the terms of trade by letting the currency float, the Chinese simply say “Why should we?” Well, because it’s not fair in the context of free trade. But the Chinese have an all-purpose get-out: we may be a major player in absolute terms, but per capita we’re still a poor developing country. So we need these little unfairnesses to help us get on level terms with you. The implication is that China won’t treat the US as an equal until their per capita economies are of similar size, i.e. when China’s economy is five times the size of America’s.

How do we get out of this double bind? We’ll see if any bright ideas come up at the G20. I’m not holding my breath.