Just before U.S. President Obama arrived in China, his hosts proffered an outspoken criticism of the negligence of the U.S. in allowing their currency to promote speculative finance. Specifically, the Chinese object to the U.S. turning a blind eye to the “carry trade.” This is a practice whereby hedge fund operators borrow U.S. dollars at low U.S. interest rates, and invest in high interest securities in currencies with higher interest rates. As the U.S. dollar slides lower, the hedge funds also gain the difference in capital appreciation of the rise in the value of the target currencies against the dollar.

The Chinese have a point. In the last year alone some 141 new hedge funds have been created. They have doing very well, on average increasing in value by 40 per cent. Some of this gain is due to buying low after security prices had been depressed in 2008; most of the rise is due to the carry trade. When hedge funds can borrow money on margin — use leverage — they can amplify their gains. Banks stand behind the carry trade by lending money to the hedge funds.

Instead of addressing the serious issue of why government bank bailout money should be funneled back into creating more speculative bubbles, the U.S. has focused on blaming China for the U.S. external deficit in international trade. American policy makers want to get the Chinese to raise the value of their currency. Even Americans who should know better such as New York Times columnist and Nobel Prize-winning economist Paul Krugman promote the view that China is undermining the U.S. dollar by keeping its currency artificially low.

The U.S. trade problem cannot be understood just from the U.S. point of view. If China were to allow its currency to rise, its exports to the U.S. would simply be replaced by those of other low cost manufacturing sites such as Vietnam, and Mexico.

The U.S. dollar problem originates in the U.S. not China. It concerns investment more than trade. U.S. debts abroad are growing due to U.S. over-spending on wars in Afghanistan and Iraq, on military equipment and on tax breaks for the wealthy and U.S. business.

In the last 50 years the value of the U.S. dollar has fallen by two-thirds as measured against the Japanese Yen, the Swiss Franc and the German Mark/Euro. This massive slide has been well camouflaged by the huge expansion of U.S. holdings abroad.

In the jargon of finance, U.S. business have been selling the U.S. economy short, placing investments in Europe, Latin America, Japan, China, India and Canada. Measured in local currencies, earnings on these investments have increased by two-thirds as the dollar has fallen by the same amount.

The standard of living of Americans takes a hit when the dollar falls in value. But cheap imports from China have cushioned the blow for American consumers. Indeed a “dollar bloc” of countries, including China, have pegged the value of their currencies to the U.S. dollar, allowing trade to continue without disruption from currency fluctuations.

It was a relief to see U.S. Secretary of State Hillary Clinton declare in advance of the presidential visit that China was a partner, not an adversary of the U.S. But on world financial issues the U.S. is not looking for partners to reform a system built around its currency. Bullying others is still the U.S. practice, and it is less and less successful. While 20 years ago the U.S. forced Japan to revalue the Yen, today America is unable to push China in the same way. Indeed China is pushing back, asking the U.S. to reform its own financial system, and calling on the world to reduce its reliance on the U.S. dollar. In the short term, neither side is going to make much progress. In time, the world is going to welcome the Chinese challenge to American financial domination.

Duncan Cameron writes from France.