It's easy to paint the US' current account and budget deficits as ticking time bombs for the US. Certainly they are cause for concern, but as Cfalk, BarfBag, and Yyz717 pointed out, the situation isn't that simple.
With the yuan pegged to the dollar, China has effectively abandoned an independent monetary policy -- the peg forces it to "outsource" its monetary policy to the US Federal Reserve. In the past, I often wondered why, with real US interest rates in negative territory, inflation hasn't shot up here as would be expected. The reason is that Asia, especially China and Japan, are sopping up the excess liquidity. The US gets cheap goods manufactured abroad, keeping prices down and domestic real incomes up, and pays for them with Treasury notes. As CFalk said, we're importing billions of dollars in actual products and exporting money in return. For the mean time, it's actually quite a nice situation for the US consumer: the Chinese are paying for our wars and tax cuts in exchange for
getting to sell us cheap stuff.
Why are they doing this? The current relationship is symbiotic, in a twisted sort of way, but it is not necessarily symmetrical. The US' current account deficit is a much bigger deal to China than it is to us. China does not yet have the domestic consumption base to absorb the massive increases in output produced by its physical investment boom. If it floats the yuan and exports crash, China's economy will crash along with it. Japan's domestic economy is stagnant; its growth is purely export-driven and depends on a weak yen-strong dollar paradigm.
In contrast, trade makes up a smaller percentage of the US' economy than any other developed nation. GDP is growing at a respectable if not spectacular rate. Despite the best attempts of the media and the Democrats to convince us that we're in another Great Depression, the labor market is in decent shape from a post-bubble perspective -- people need to realize that the late 1990s were a speculative aberration, not a healthy and sustainable climate, and are not coming back. While it wouldn't be pretty, the US could live without China and Japan. China and Japan cannot live without us.
On the other hand, China's current policies are unsustainable. Its trade surplus and pegged currency force it to continue buying Treasury bills to prop up the yuan. This causes rapid expansion of the domestic monetary base, and China cannot tighten up the money supply without breaking the peg. The result is inflation: CPI growth is reaching double-digit levels in spite of deflationary increases in output. Producer prices are likely rising even faster. Making matters worse, the investment boom is at least partially a speculative bubble fueled by loose monetary policy. This is compounded by the government's determination to direct investment into politically expedient but economically inefficient routes.
The risk of a hard landing is real. http://www.atimes.com/atimes/China/FK12Ad05.html
sums up the situation nicely. In particular, this chart is the best analysis I've seen:
In many respects, China's situation is much more unstable than America's. Absent a complete abandonment of economic liberalization, it is probably inevitable that China will one day become an economic superpower, but that does not mean the road will be smooth and easy. There is every reason to believe that China's meteoric rise will not continue indefinitely.
The US Federal budget deficit is not especially high as a percentage of GDP. It has historically been at significantly higher levels, especially during the World Wars and in the early 1990s, and other countries' debts are much larger as a percentage of GDP than ours is. The US faces far more serious long-term demographic problems
, specifically the massive unfunded liabilities looming in Social Security and Medicare. These must be addressed sooner rather than later: I would rather have the government spend $2 trillion now transitioning Social Security to a viable long-term structure than face a $20 trillion accumulated deficit when the so-called "trust fund" runs out circa 2030. Compared to $50+ trillion in unfunded liabilities coming due in the next half-century or so, an $8 trillion debt accumulated over the past 25 years is not terribly worrisome.
[Edited 2004-11-22 07:28:18]
Keynes is dead and we are living in his long run.