Another way to think of it is that China would be giving us $1trn worth of stuff for only the cost of servicing that $1trn of debt (remember to subtract inflation). Does that make us or them poorer? Think carefully.
Sure, it'd be better to use the money productively, then we get two things: $1trn worth of gadgets + whatever $1trn bought in the U.S.
And, of course, one could do worse than burn $1trn. One could finance one's enemies, for example.
The OP asked what if the US borrowed $1trn from china and spent it. Where does this $trn worth of gadgets come from in that scenario?
Therefore "what if China lent the U.S. $1trn ..." is roughly equivalent to and interchangeable with "what if China sold $1trn worth of trinkets to the U.S. ..." and vice-versa.
Today's mercantilism is all of this form: country X maintains a long-term trade surplus with the U.S., forces its exporters to exchange their dollars for local currency, and then country X's central bank buys U.S. treasuries (i.e., lends to the U.S. government) with those dollars. Yes, those central banks could purchase other dollar-denominated assets, and if the U.S. Federal government did not engage in deficit spending then those central banks would have to buy other dollar-denominated assets -- or they would have to let exporters keep their dollars and figure out what to do with them, or perhaps trade would have to balance.
Another way to put this is that Congress' deficit spending drives the U.S. trade deficit. If the U.S. budget suddenly went into long-term surplus then the mercantilist nations would have to start buying other dollar-denominated assets, or else the trade deficit would have to swing into surplus (which would then see the U.S. become a mercantilist nation...).
So when someone says "what if China lent the U.S. $1trn and ..." what they're saying is equivalent to "what if China exported $1trn worth of trinkets to the U.S. and ...". And look! It's what actually happens. China maintains a long-term trade surplus with the U.S., so it's continually selling $$$$' worth of trinkets to the U.S. and continually lending similar amounts of $$$$ to the U.S.
Compare to "what if China lent the U.S. 10trn Renmimbi and ..." -- completely different idea, though, of course, the U.S. only borrows in dollars.
Yes, I didn't say all this earlier, but people should really know this (people really don't). EDIT: The 15 upvotes above are from people who do know these basic facts of economics.
Yes, I said this ("dollar-denominated assets").
> China could just as easily export oil to any country inn the world in exchange for us dollars.
Let's think this through (ignoring the fact that China is a net importer of oil, so they wouldn't export any oil). China sells stuff to Europe for dollars. Whence those dollars? Europe probably had treasuries, sold them, and paid China... except that actually they'd just transfer the treasuries -- why pay extra fees? Whence those treasuries? Well, Europe sold... stuff for dollars and so on.
(Actually, Europe borrows in euros, so euros too are a reserve currency, but let's ignore this. So it's not right for me to use Europe in the example above, but let's pretend for the argument's sake.)
Few things in economics are zero-sum games, but one thing that is a zero-sum game is international trade. If China maintains a trade surplus with the rest of the world, then the rest of the world maintains a trade deficit in the same amount. The U.S. dollar is a reserve currency because there is nothing else now to use as gold used to be used, and the rest of the world insists on maintaining a trade surplus with the U.S., which means they... have to accumulate dollars or dollar-denominated assets.
Because of this, the rest of the world can also trade with each other in treasuries, and so you're absolutely right about that. But new lending of dollars to the U.S. most likely stems from exports to the U.S. Certainly that would be true for any sufficiently large sums: the creditor could not accumulate such sums without exporting to the U.S.
So I stand by the assertion that for China to lend $1trn to the U.S. means to export a similar amount to the U.S. as well.
OK, if I accept that then I'm left with the idea that it's a really bad policy. The stuff we bought from China has a useful lifetime (food gets eaten, products wear out), but the money we owe them does not - barring inflation of course.
You also risk unrests what with pensions cut and similar effects.
Look at Greece, they went through hell just not to default (again).
They definitely defaulted.
In the end, once the US is caught with it's pants down it will definitely not be making the US any richer.
Or, you know, investing the funds in infrastructure and other improvements that yield more benefit than the debt service costs.
Or—though there are ethical issues with this—using some portion of the borrowed funds to subvert or other displaced the lending government and cancel the debt. [0]
There's probably other mechanisms besides these, as well.
[0] Although eventually this was reversed by an outside coalition, Iraq did the brute force version of this to Kuwait in 1990.
Mind you, mercantilism can have significant detrimental effects on the importer -- no doubt. But it's not all roses for the mercantilist exporter either.
Really, a multi-decade trade imbalance is not a good thing for anyone, but it's not that clear who is the worst off.
Is it bad because of the opportunity cost of not levering up and investing research and future productivity growth?
The only way you can use those IOUs is if the roles are reversed and the U.S. starts maintaining a trade surplus with the rest of the world (and so the rest of the world a trade deficit with the U.S.).
Before the dollar became the reserve currency of the world, the world settled trade in gold. With gold as the reserve currency it was very important to not run out of gold, and this served to keep trade balanced in the long term (and probably also served to keep the lid on growth of international trade, since to buy one kind of thing you'd have to sell some other kind). Incidentally, the concept of comparative advantages is probably a lot more meaningful in the context of balanced trade...
But the dollar is the reserve currency. Which means that the world maintains a trade surplus with the U.S. Which means they export things to the U.S. in exchange for IOUs that will get them nothing much (it does help to defend their currencies during crises, but not much more).
Meanwhile, Chinese people (in China) are effectively paid less than they should be for the labor they put into manufacturing things to sell to the U.S. This is obvious in that China forces exporters to exchange their dollars for Renminbi, which means those exporters can't buy other things with those dollars than Renmimbi. Also, all those factories in China make things people want in the U.S., not things that people want in China (though maybe there's a lot of overlap).
So my take is that mercantilism hurts the mercantilist. It does also hurt the importer in different ways: by reducing employment, for example, and removing productive assets for another, and these things might hurt more when it comes time to rebalance world trade. Who knows, maybe Chinese people in China and Americans will gladly continue this state of affairs. But somehow I doubt it.