Most sources would tell you that the Chinese are worried because they feel that the Americans are spending their money recklessly and not paying any attention to their debt and thus worried in whether the Americans would repay the debt that it owes to China.

They are also worried that the US dollar would devalue and would make its trillion dollar investment in American debt would not be worth it. There is also concern that the investment in US debt would not be good as the Federal Reserve in the United States have is keeping interest as low as possible. This would mean that the Chinese government would earn more money by investing it elsewhere rather than keeping its money in US Treasuries and notes.

This also leaves the Americans worried. Most of the money for the Iraq war and for the lack of the revenue caused by the Bush tax cuts came from the Chinese. The money for the current stimulus package comes from the Chinese. And where exactly would the US find the money to pay back this trillion dollars to China? Another country, perhaps.

As of the time this article was being written, there is little change in the Dow Jones Industrial Average. It was trading up 0.1%. However, one has to take into context of the news that Citibank announcing that it would not need any more tax payers money to survive. These two news seem to cancel out each other so far. In other words this news is to a certain extent dragging the Dow Jones Industrial Average down.

China seems to threaten that it would not invest in US treasuries thereby forcing the Americans to raise money on their own. This is because, should the US print money to pay back this debt, it would raise inflation all across the world and this would make the money that China lent is less worthy.

But what is the real reason really? The answer lies in the trade deficit between China and the US. China was manipulating her currency (the Yuan) and keeping it artificially low by buying US debt. This created a thirst for even more Chinese goods and made the deficit bigger, giving China a bigger incentive to buy American treasuries.

With the current economic crisis, American consumers has decided not to spend and buy a lot of Chinese goods. This makes the trade deficit lower and virtually nullified according to Chinese sources. Now the value of a weak yuan would not do much as Americans has a lesser consuming power than they used to. So now the Chinese are saying “Why should I lend the Americans? What would I get int return?” Before they benefited by Americans buying more of their goods, now they do not.

That being said though, I dare the Chinese to stop playing these games and manipulate her currency in the long run. I really dare them to do so. America is China’s biggest customer. China has long benefited by this lop-sided trade deficit.

A good example would be comparing it to neighboring Japan. Both these economies are export driven economies. Due to the current global crisis, both have exports that have been hit badly. China’s exports are now three quarters of what it was a year ago while Japan’s export are half of what they were a year ago. Yet we do not see the same level of destruction in the Chinese economy as compared to the ravaged Japanese one. This is all down to the money that China lent the US.

What I suggest is for the US to bite the bullet now than suffer worse consequences later. The economy is already bad. Deflation is a problem right now, not inflation. I would rather have the Americans pay off the Chinese with “worthless” money right now than let them be at the whim and fancies of the Chinese later.

This would not be an easy decision for the Americans to make. For one, this would easily cost the American public a lot thanks to the inflation and in a time where there are no jobs, that would also cost the Democrats the elections in 2010. The US too would find it more difficult for them to carry out all the ambitious agendas that President Obama has laid out.

Here is my reason why. Firstly, if there is ever a need for inflation in America, this would be it. Secondly, when goods overseas become more expensive, American and other investors would spend more money in America thereby creating jobs in the mid term ( 4-6 months). In the long term everything would even out as foreign countries that also depend on the US for a market on their goods would also see their currencies gradually decrease against the dollar thereby strengthening it.

The last reason is that China has been reacting very brashly with the United States in recent days. First was the incident in the South China see where the American vessel was surrounded by Chinese vessels in international waters. A few days later came this threat about not investing in US Treasuries. And as long as the US owes China something, China would always leverage that against the US.

I think the US should stop the buck now. She should not allow China to use the debt that she bought for her own use against America. I believe that this should be a once and for all thing that the US should do. Taking action that would hurt China would also send a strong statement to the other countries that US owe its money to, against using the Treasuries to blackmail America.

I really hope that Premier Wen starts to regret ever outbursting like that just because there is some sentiment in China to take back this money in hard times.

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