John Maynard Keynes once observed that if you owe someone £1,000, you’re at his mercy; if you owe him a million, he’s at yours. But what happens when one nation owes another $800 billion? It would seem that they’re jointly at each other’s mercies, unless they are capable of fundamental change.

Whether nations are so capable will decide the epilogue to the US-China imbalance story that is slowly gaining currency as a major factor behind last year’s financial panic, as also a major solution to the world’s ills. It now forms the backdrop to US President Barack Obama’s visit to China this week.

Illustration: Jayachandran / Mint

The story begins in the 1970s, when China embraced the West’s markets while US companies, troubled by trade unions in an age of stagflation, pushed off to the East. Cheap Chinese exports—anchored by the yuan’s peg to the dollar—helped a consumption binge. In turn, China’s trade surplus has over the years added to foreign exchange reserves now worth $2.2 trillion. This surplus had to be invested somewhere; China chose the world’s most liquid asset: dollar-denominated US treasurys. This demand lowered interest rates, fuelling further consumption.

We repeat this prologue only because it shows how the last 30 years may have rendered imbalances inextricable for economic stability in both these nations.

In China, prosperity has had an urban bias. Hung Ho-Fung explains in November’s New Left Review how lack of rural development prompted urban migration, while depressed wages kept consumption low. The resulting emphasis on investment benefited coastal centres: Little surprise that a coastal elite now dominates the Chinese government, especially at the highest levels. Alter this model, and the foundations of Chinese political economy—an authoritarian state already insecure about the slightest protest—could crack.

On the other side, author Fred Goldstein notes in his Low-Wage Capitalism (2009) that the largest employer in the US economy has transformed from the well-paying General Motors in the 1970s to a stingy Wal-Mart today. Workers haven’t minded this because both cheap goods and cheap credit were available, courtesy China. Increase US interest rates or cut off cheap imports, and the US labour market may be looking at an upheaval.

This leaves the middle chapters of this story ambiguous. Washington wants the yuan to appreciate—a point Beijing both admits and gets adamant about, as it did last weekend. China blames loose US monetary policy—as its banking regulator did over the weekend—to which Washington nods, but still insists on maintaining low rates for “an extended period". All the while, both sides seem farther from a resolution, holding the rest of the world at their mercy.

How will US-China imbalances be resolved? Tell us at