The China Syndrome

Much has been made of the United States' indebtedness to China. This discussion usually revolves around the questions of just how much is too much debt given our economic circumstances and what happens if China decides to stop lending us so much money.

This second question assumes that China's lending decisions are matters of their willingness rather than their ability. This shows up as speculation that China may hold fewer dollars and more euros, for example.

In the New York Times, Tyler Cowen, economics professor and blogger, has an alternate narrative about just how the relationship between the U.S. and China could change, and not for the better:

China uses American spending power to enlarge its private sector, while America uses Chinese lending power to expand its public sector. Yet this arrangement may unravel in a dangerous way, and if it does, the most likely culprit will be Chinese economic overcapacity.

And the consequences of overcapacity?

In economic terms, the prices of Chinese exports will probably fall, as overextended businesses compete to justify their capital investments and recoup their losses. American businesses will find it harder to compete with Chinese companies, and there will be deflationary pressures in both countries. And even if the Chinese are selling more at lower prices, they may be taking in less money over all, so they may have less to lend to the United States government.

This is doubly troubling since it may represent another deflationary pressure on the global economy, which could result in additional economic chaos; on the fiscal front it represents the possibility of an abrupt reduction in the flow of the funds we are counting on to continue federal expenditures. A reduction that is imposed by economic conditions in China and that may not be easily reversed even if the Chinese leadership desired to do so.

Cowen ends imploring us not to be lulled into a false sense of security by the current low borrowing costs. He also warns that for all the worrying we have done lately about a rising China and a fading America, a weakening of the Chinese economy may be more dangerous.