It is true that, although China’s rate of economic growth has been high for two decades, the income per person is still moderate. But individual Chinese citizens and companies save much of the money they earn. They restrain their purchasing and save. After the trauma of civil wars in the 1920′s, the Japanese invasion in the 1930′s, the communist revolution the 1940′s, the “great leap forward” that led to mass starvation in the 1950′s, and the Cultural Revolution and “witch trials” of the 1960′s, all Chinese know that anything can happen and some it can be bad. Save for the rainy day.

As a result, the nation exports much more than it imports. That is especially true of manufactured goods. Like many developing countries, China imports raw materials and uses those to make consumer goods or parts for machinery like PCs and cars. Most international trade is earmarked in dollars. Even of you export the shirts to Belgium you’d prefer to be paid in US dollars. So, they must do something with that excess cash.

Fortunately, their friend across the Pacific, the USA, is filled with consumers who shop till they drop. And keep shopping with money they borrow. And the US has a government that had a surplus in the 1990′s but went way into debt to pay for Iraq even as it was cutting taxes. So, America must borrow. China will lend by buying US debt. While Chinese leaders speak of dumping dollars for another currency, there is little prospect of that. Europe doesn’t run a huge trade deficit so there aren’t that many Euros to go around. The same is true for Japan, where the interest rate China could earn is even lower than for the US. America has the world’s broadest pool of liquidity. It’s the easiest place to stash the cash. With our current level and growth of federal and state debt, we will need China’s lending and they will need our IOU’s for many years.

The US government runs deficits and has a deficit… their deficit is well over $10 trillion dollars.

People have to buy that debt… China owns over $1 trillion now, Japan has around $800 billion, the Middle-East has around $800 billion, and I don’t know who owns the rest… probably private groups and individuals.

The trade deficit is caused by America importing more than it’s exporting. It’s a fairly large imbalance that has not been fixed even with the global recession. China is one reason – they make a ton of cheap products.

How are they buying them? The bonds are auctioned off, so anyone can buy them…

Why would China buy American debt? Because the United States consumes their products which makes their economy grow.

It’s a bad relationship – America goes deeper and deeper into debt (not just government but individual citizens) buying Chinese products – and the Chinese finance the Americans with money they get from making the products.