Monday, May 03, 2010

China and the US Debt

China and the United States: The Bonds of Debt, by Donald D. Hester
Professor of Economics, Emeritus
The University of Wisconsin – Madison

This paper explores the large and growing indebtedness of the United States to the People’s Republic of China. Beginning with the 1971 reestablishment of diplomatic relations between the two countries, international trade between them expanded but was very modest until the mid 1980s. At that point, China under Deng Xiaoping adopted a variation on the successful export strategy that had been pioneered by Japan and the smaller Asian “tigers”. The first section of the paper analyzes the distinctive features of this variation and provides tabular information about trade and foreign exchange balances and the exchange rate between the dollar and yuan. The second section proposes a crude game-theoretic discussion of what each country might gain and lose from their large growing financial entanglement in the short and long run. The third section is a discussion of the limits of the imbalance and how U.S. debts to and Chinese claims on other countries impact the relation between the P.R.C. and the U.S. The concluding section focuses on the paradox of a poor and rapidly growing authoritarian country financing an undisciplined and relatively declining democratic superpower.