Beijing prints yuan, to purchase dollars in foreign exchange markets—suppressing the value of the yuan against the dollar by about 40 percent. It uses those dollars to purchase U.S. Treasuries and other western debt, and buy oil and other mineral deposits around the world.
The net effect is to suppress medium and longer-term U.S. interest rates. For example, when the Federal Reserve raised the federal funds rate from 1.25 to 5.25 percent from 2004 to 2007, bond rates did not much rise and mortgage money remained cheap and easy, helping finance the U.S. real estate bubble. Similarly, easy credit helped the U.S. and European governments dig into their present fiscal messes.
China buys so much U.S. debt that it effectively caps U.S. medium and long term lending rates. And in a recession, efforts by the Federal Reserve to spur economic activity by cutting overnight lending rates to near zero or purchasing government bonds or mortgage-back securities do little to lower medium and longer-term lending rates and encourage business spending or new home purchases.
President Obama has countered with massive stimulus spending but temporary tax cuts generate a lot of savings and his spending on real goods have too often gone into Chinese imports or projects that only displace private investments. For example, the amount of commercial space built over the next several years depends on anticipated demand, and subsidies for green buildings only change the character of what gets built, but not very much the absolute amount of space that gets constructed.
The combination of a huge trade deficit with China and credit bubble busting has left U.S. housing and other asset prices deflated, unemployment near ten percent and the U.S. economy laboring under deflationary pressures.
Deflationary pressures play out in high unemployment or falling prices, and so far we have gotten a lot more of the former than the latter.
China has enjoyed breakneck growth but all those yuan printed to buy dollars have returned to China, through export sales and foreign investment, and have created Chinese inflation and asset speculation.