The way it really works is way crazier. Imagine each household in the neighborhood has their own “credits”. The parents give them to their kids when they get good grades. Each family has it’s own currency; let’s call the Brown’s currency the “B”, the Jonses’ the “J”, the Smiths the “S”, etc. Each currency is valued independently. Mr. Brown decided that 10B buys one cotton candy or one GI Joe figurine, while Mrs. Jones values cotton candy or a GI Joe at 5J.

OK, now lets say the kids trade each other their credits to get each other to do homework for each other. A Smith kid offers a Jones kid 15S for one math assignment. Now the Jones kid has some S currency. He can either use it later to buy a homework assignment from a Smith kid, or just trade it with someone who has his family’s currency, the J.

Finding someone to trade currency with will become a pain, particularly for kids that do homework for others much more than they pay for others to do their homework. Let’s say one kid in particular, Ned Nelson, does a lot of homework for all the other family’s kids. He ends up with a huge stash of every kind of currency, and decides he’s gonna dedicate himself to helping the rest of the neighborhood, by serving as a go-to source for exchanging different forms of credits.

So after Balthazar Brown gets paid 10J for doing math homework for Jeremiah Jones, he goes to Ned and exchanges it for 20B. You could also say Balthazar “buys” 20B from Ned at the “price” of 10J. This depletes Ned’s supply of B’s, and increases Ned’s supply of J’s. What’s interesting is these supply and demand changes affect the prices Ned sets, just like it would any other merchant. So as Ned’s supply of B’s is further depleted, he raises the price of B’s, costing buyers to exchange more and more J’s (or other currencies) to get the same amount. So overall, if a lot of Browns are selling their homework services to the Jones, Ned’s supply of B’s is gonna start going way down, which in turn will send the price of B’s way up.

Will the B’s price eventually get so high they cost virtually an infinite amount of other currency? No, these prices have a way of correcting themselves with the help of trading of services between families. As the Brown kids get less B’s back for the J’s the earned, when they get back home they aren’t able to buy the same amount of cotton candy and GI Joes as the used to. To counteract this, they raise the price of their homework service. Higher prices means fewer Jones will be willing or able to buy it. When less of them buy, less J’s end up in the Browns’ hands. When the Browns show up later at Ned’s with fewer J’s than last time, Ned’s supply of B’s is not depleted as much. We can assume he’s getting some B’s from other kids who sold homework to the Browns. If he gets enough B’s from those kids to balance the B’s that the Browns want, his supply of B’s can stay the same and he doesn’t need to raise prices on the B’s. At that point, the overall relationship between the Jones and the Browns has reached an equilibrium of exchange rates (J’s for B’s) and trade amounts (fewer Jones buying homework from Browns).

This is what USA would expect to see with China: like the Jones, the more we buy foreign products/services, the higher their prices should become, causing us to buy less. Instead, their prices stay the same no matter how much we buy? Why?

Well if Mr. Brown does what China does, he wouldn’t let his kids go to Ned. Instead he’d require that any of his kids that want to trade foreign credits for B’s has to go through him (under penalty of timeout). This is cool by them because he actually gives them more than Ned would, enough so that they are able to buy the cotton candy and GI Joes that makes all that extra homework they did worthwhile. In this case, they don’t feel the need to adjust their prices up at all, and the Jonses can keep up the same rate of consumption of their services.

But where does Mr. Brown get all those B’s? Three sources: first he does go to Ned and trades away some of the J’s (or whatever currency) as long as Ned’s prices are reasonably low, second he borrows some from his other kids in exchange for an IOU with interest, and the rest he literally just makes.

His meddling doesn’t stop there. Now he’s got all these extra J’s that he wasn’t willing to trade with Ned. He takes these J’s and goes out to the playground where the Jones kids are hanging out, and asks if any of them want a loan. “50J, but you gotta pay me back 55J in 20 years.” That’s a bargain (0.5% interest!), so the kids jump at it. “Think of all the extra cotton candy and homework we can buy.” Thus they actually add some of that money to the normal amount they spend on Brown homework services. And the whole cycle begins again, a little more amplified than the last. With each cycle, the Jones are leveraged a little more than the last time. It’s really a bit scary.

Eventually the Jonses are heavily in debt to the Browns. But the Browns aren’t in the clear. If the Jones default on that debt, the Browns are left holding the bag, and their entire economy can unravel too. All of Mr. Brown’s kids that lent him B’s for IOUs won’t get paid back! And those kids that are holding a bunch of J’s having just finished another back of the Jones’ homework won’t get anything for those J’s from Ned either; the J’s have no value anymore.

So China’s economy is growing as we basically give them our money over and over. But the longer this arrangment goes on, the more entangled the two economies become and the more fragile the entire situation gets. Like some illicit affair, so wrong, but for now it feels so right.