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By Root 1179 0

the world’s leading power is challenged by a rising one, the two have a difficult relationship. And while neither side will admit it publicly, both China and the United States are worried and planning for trouble. For three decades, Chinese foreign policy has been geared toward satisfying the United States for a variety of practical reasons. First it was anti-Soviet strategy, then a desire for markets and reform, then rehabilitating the country after Tiananmen Square, membership in the World Trade Organization, and finally the Beijing Olympics. But increasingly, China’s younger elites believe that their country needs to think of itself as a competitor to Washington in several senses. In Washington, there have always been those who see China as the next comprehensive threat to American national interests and ideals. To say this is not to assume war or even conflict, but merely to note that there is likely to be tension. How the two countries handle it will determine their future relations—and the peace of the world.

The nations are so entwined that even basic economic activities like borrowing and saving assume globe-altering dimensions. Chinese households and corporations tend to be cautious. They bank about half their earnings, always preparing for the metaphorical rainy day. Such extreme thriftiness in combination with high growth led China to accumulate vast new pools of capital over the last decade or so. But this was not simply a Confucian cultural trait. The Chinese government discouraged spending and encouraged savings, in part as a way to ensure that inflation stayed low and the currency stayed undervalued—which made Chinese goods cheap and attractive to the Western consumer. In addition, countries like China were soured by the Asian crisis of 1997, when Asia’s economies fell and Western bankers came to the rescue but demanded onerous terms. After they recovered, Asian governments—and others outside Asia as well—decided to accumulate their own reserves, so that the next time around, they wouldn’t have to rely on the kindness of strangers.

So, instead of reinvesting their ever-growing savings in their domestic economy, Chinese authorities stashed it away. But how should a government hoard its money? By buying what was then—and still is now—considered the safest investment in the world: U.S. treasury bills. Through their accumulation of massive quantities of American debt, the Chinese ended up subsidizing the behavior that caused it—American consumption. They financed our spending binge and built up a vast hoard of dollar IOUs. The Chinese oversaved, the Americans overconsumed. The system seemed to balance out.

It wasn’t just China, of course. Eight other emerging-market countries have accumulated war chests of $100 billion or more, mostly in dollars. But China alone sits on foreign-currency reserves of $2.5 trillion, again most of it in dollars. In September 2008, China became America’s largest foreign creditor, surpassing Japan, which no longer buys large amounts of U.S. treasuries. (With 10 percent of all currently outstanding T-bills in its possession, China is likely America’s largest creditor, period, but the U.S. Treasury doesn’t track domestic lenders.) China now holds the world’s largest IOU slip, and it carries the signature of Uncle Sam.

Oversaving is as much a problem as overconsuming. The Harvard economist Dani Rodrik has estimated that sending so much money abroad instead of investing it productively costs the Chinese roughly one percentage point of GDP a year, or more than $40 billion annually. China’s lending was also essentially a massive stimulus program for the United States. During the go-go years of the mid-aughts, it kept interest rates low and encouraged homeowners to refinance, hedge fund managers to ramp up leverage, and investment banks to goose their balance sheets. China’s lending created cheap money, says the Financial Times columnist Martin Wolf, and “cheap money encouraged an orgy of financial innovation, borrowing and spending.” It was one of the major contributors to the global