Reporting from Washington and Beijing — For much of the last decade, the economic relationship between the U.S. and China was like a bartender and his favorite patron.
American consumers knocked back flat-panel TVs, laptops and assorted other made-in-China products while Beijing rang up the charges, extending more and more credit so the customer could keep drinking.
On paper, the Chinese accumulated hundreds of billions of U.S. dollars. But instead of cashing in its horde, China lent much of it back to Americans to help finance ever-higher consumer borrowing, as well as federal deficits and cheap mortgages.
It was a mutually beneficial arrangement -- until the morning after, when bartender and customer blamed each other for a doozy of a hangover.
With the Great Recession putting that mountain of American debt in a new, unsettling light, the two countries are eyeing each other with growing resentment -- each showering the other with unwelcome demands for policy changes.
The tensions are being aggravated by domestic politics in both countries.
"The proverbial train wreck may be coming to pass," said Nicholas Lardy, a prominent China expert at the Peterson Institute for International Economics in Washington.
Chinese officials have begun to warn that if Washington doesn't curb its widening deficits and stop badgering China to make concessions on currency and export policies, Beijing may begin dumping dollars. Or it might at least cut back on the massive buying of Treasury bonds that Washington depends on to finance its deficit.
Such a response could inflict economic pain on millions of Americans, costing jobs and hurting the recovery, some economists say.
But China is over a barrel too. If Beijing tightened the screws, the value of the dollar would decline. The value of China's holdings would shrink as well, as would Americans' consumption of Chinese products. Even with the recession, U.S. imports from China amounted to a whopping $296 billion last year, while exports to China were just $70 billion, according to U.S. data.
Beijing has no ready replacement for the U.S. as its biggest customer. And years of rapid growth and rising prosperity have created popular expectations in China that the ruling communist hierarchy cannot easily ignore -- especially the opinions of its increasingly vocal business community and middle class.
The basic question is how to reshape the U.S.-China relationship on a more sustainable and balanced basis. That process is almost certain to require uncomfortable changes on both sides.
But right now, the historic drama is playing out in an arcane argument over currency exchange rates -- the value of the Chinese yuan versus the U.S. dollar.
Scores of U.S. lawmakers have demanded that China strengthen its currency, so its goods wouldn't be so cheap in the U.S. and other foreign markets. Raising the value of the yuan could also encourage China to buy more American products.
"The silence of our government on China's currency manipulation has become the silence of our factories," said Sen. Olympia J. Snowe (R-Maine), a senior member of the Senate Finance Committee.
She and other members of Congress are pushing the Treasury Department to label China a currency manipulator in its next review, due April 15, which could lead to tariffs on Chinese goods.
Outside Congress, leading free-trade proponents, including Nobel Prize-winning economist Paul Krugman, have joined labor leaders such as Leo W. Gerard, international president of the United Steelworkers union, in denouncing Beijing's refusal to act.
Twice in the last two months President Obama has called on the Chinese to act on their currency. Each time he got a sharp, negative response. In part that may have been Beijing's instinctive reaction against being told what to do, but that's far from the only reason.
"For the Chinese government, it's not only about losing face and confidence, it's also about the economy," said Zhou Shijian, a senior research fellow at the Center for U.S.-China relations at Tsinghua University who cited a 16% drop in Chinese exports last year. "Appreciating the yuan will impact the economy and social stability, not just face."
Outside China, few dispute that the yuan is undervalued, and most say by 25% or more. But there are differences over how much even a big increase in its value would help employment in the U.S. -- or hurt it in China.
Drew Greenblatt, president of Marlin Steel Wire Products in Baltimore, calculates that he could double his company's payroll to 60 if the Chinese currency rose by 25% or more against the dollar. That would more than offset the 10% to 15% cost disadvantage that Marlin's wire baskets now have against made-in-China competitors.
Revaluing the yuan "would absolutely help my business," Greenblatt said.
Krugman, the economist, estimates that China's currency policy -- and resulting large trade surpluses -- may end up costing about 1.4 million jobs in the U.S. in the next couple of years.