Some people just don’t know when they’ve got someone else over a barrel.

There is an old saying which goes something like, “When you owe the bank a little money, you’ve got a problem. But when you owe the bank A LOT OF MONEY, the bank has a problem.”

Many Americans think that the large amount they owe China and other foreigners is a US problem. I suggest that if the US played its cards right, it would become a severe headache for foreigners and a source of profit for the US.

The US, instead of providing its economy with enough stimulus has allowed China and others to come to it’s “rescue” with billions (that the US could perfectly well have printed itself).

What the US should do is create enough new money to bring employment back to where it was, or near where it was prior to the crunch. Maybe it would even be an idea to print a bit MORE money than is really needed so as to bring about an inflation rate of 4% or so.

That would mean the debt to foreigners would decline in real terms at 4% a year: headache No 1 for foreigners.

As to the interest rate offered by the US to those wanting Treasuries, this should be a miserable 1% or so. In fact the Fed could have a big notice over its front door: “We’ll borrow just as much as you are able to lend us, you suckers. We’re open for business 24/7”.

Of course, the reaction of foreigners would be to seek out other borrowers. But if a significant portion of other sovereign borrowers adopted the same policy, the lenders would have nowhere to go.

A possible catch with the above policy is that the Chinese government is not as stupid as the US government.

That is, the best policy for the Chinese to adopt in reaction to the above “1% Treasury” idea would be to cease lending: that is gradually sell off their Treasuries and use the money to buy US goods and services and ship those products back to China. That constitutes a REAL repayment of debt. I.e. the debt is repaid in the form of real goods and services. And that would involve a temporary standard of living hit for US citizens.

Alternatively, foreigners might use the money to invest in US industry. That would involve no standard of living hit for US citizens.

But the Chinese have a phobia about imports. They are determined to export as much as possible, and build up stocks of other countries’ sovereign debt. So there is a good chance they wouldn’t go for the latter rational policy. That is, there is a good chance they’d just plonk their surplus dollars in U.S. banks, who wouldn’t have much use for the money, and who would thus offer a rate of interest even more miserable than the above 1%.

As long as someone behaves irrationally, there is money to be made out of them. Someone somewhere ought to have them over a barrel.

Note added 21st March 2011: Nice to see someone else tumbling to the fact that borrowing money from other countries so as to get out of a recession is totally unnecessary, since the U.S. can print its own dollars. See fourth para here.