In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending.

The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption.

This colossal credit cycle could not last forever, he said. But in a global economy, the transfer of Chinese money to America was a market phenomenon that would take years, even a decade, to work itself out. For now, he said, “We probably have little choice except to be patient.”

Today, the dependence of the United States on Chinese money looks less benign. And the economist who proposed the theory, Ben S Bernanke, is dealing with the consequences, having been promoted to chairman of the Fed in 2006, as these cross-border money flows were reaching stratospheric levels.

In the past decade, China has invested upward of $1 trillion, mostly earnings from manufacturing exports, into American government bonds and government-backed mortgage debt. That has lowered interest rates and helped fuel a consumption binge and housing bubble in the United States. China, some economists say, lulled American consumers, and their leaders, into complacency about their spendthrift ways.

In hindsight, many economists say, the United States should have recognised that borrowing from abroad for consumption and deficit spending at home was not a formula for economic success. Even as that weakness is becoming more widely recognised, however, the United States is likely to be more addicted than ever to foreign creditors to finance record government spending to revive the broken economy.

... contd.