[JackFr]

As an identity, the capital account between two countries -- payments made for capital: land, buildings, financial assets, etc. must equal the current account payments made for goods and services.

When we buy stuff from China, they get dollars. If you have a surplus of dollars you want to invest them in something, and that something has to be dollar denominated. Treasury bonds are safe, liquid and politically palatable for all sides.

If we stopped buying their stuff, they would stop buying our bonds. If they stopped buying our bonds, they would have to find somewhere else to invest dollars.

(Interesting side note -- this dilemma is what led to the creation of the Eurodollar market -- in the early 1970's the Soviet Union had dollars from oil sales (the international crude oil market is dollar denominated) and they did not want to put the money into US domiciled banks -- so the London banks said we will accept dollar deposits, but are not accountable to the Fed or other US authorities in these accounts (nor can we borrow at the Fed window) and thus was born the eurodollar.)

[avn2109]

This is a bit of history which they never mentioned in Econ class. Politically inconvenient for some actors and very interesting.