More Money, More Problems

By HU YUE

More Money, More Problems

By HU YUE

The U.S. quantitative easing policy could have a negative impact on the world economy and repercussions for China

B y revving up its money-printing machines, the United States w ill try to shock its economy back to life. But for the rest of the world, China included, this means financial uncertainties.

On Novem ber 3, the Federal Reserve announced it would buy $75 billion of long-term Treasury bills each month until the end of June 2011. The monetary expansion was accompanied by a pledge to keep interest rates at ultra-low levels for an “extended period.”

In addition, U.S. policymakers have left the door open for an even bigger capital injection should grow th remain lackluster. The Fed said it would “regularly review the pace of its securities purchases and w ill adjust the asset purchase program as needed to best foster maximum employment and price stability.”

This is the second round of quantitative easing (QE2) after the Fed purchased $1.7 trillion worth of mortgage-backed securities and Treasury notes between December 2008 and March 2010 in a bid to prevent what would otherwise have been a deeper recession.

Supporters argue that QE2 is needed to speed up the pace of the U.S. recovery, since no other options are available now that the Fed has already lower interest rates close to zero. However, econom ists doubt the policy’s effectiveness and fret over its ripple effect on the global economy.

“One danger lies in whether other nations will follow the U.S. lead in devaluing the greenback,” said Constance Hunter,chief economist at Aladdin Capital Holdings LLC, an investment bank based in Stam ford,Connecticut.

If one country devalues its currency, it can have a number of benefi ts, such as eliminating debt through inflation or jump-starting the economy. But if every country engages in competitive devaluation, it could cause deflation, she said.

The quantitative easing will lead to torrent capital inflows into emerging markets and create asset bubbles that could destabilize the world economy, said Shi Jianxun, an econom ics professor at the Tongji University based in Shanghai.

It is actually a form of indirect currency manipulation that could lead to a new round of currency wars and even a global econom ic collapse, he said.

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Joseph Stiglitz, a professor at Columbia University and Nobel econom ics laureate,told Xinhua News Agency that the cost is bigger than the benefit when taking these moves. He noted that what the United States needs now is a second round of fiscal stimulus policies, not more liquidity.

Central banks in emerging markets are being forced to choose between passively letting these capital inflow s push up their exchange rates—thereby negatively affecting their exports—or recycling these inflows into the U.S. Treasury bills yielding only 1 percent w ith a declining exchange value, said M ichael Hudson, an economics professor at the University of M issouri.

Troub le for China

As the United States floods its economy w ith cheap credit, the greenback faces significant pressure to depreciate, casting an om inous shadow over the security of China’s dollar assets.

In August, China boosted its holdings of U.S. Treasury securities by $21.7 billion to $846.7 billion, retaining its position as the largest foreign holder of U.S. government debt. The debt purchase is part of China’s strategy to diversify its piling foreign exchange reserves, the world’s largest at $2.65 trillion by the end of September.

M eanwhile, a weaker dollar w ill erode the competitive edge of Chinese goods, rubbing salt in the wounds of hard-hit exporters, said Lu Zhiming, a senior researcher at the China Bank of Communications.

The worst-case scenario would be a dangerous currency war and trade protectionism if more countries join quantitative easing, said Lu.

China’s turbo-charged export machine came to a halt in early 2009 as foreign consumers were reluctant to spend. The sector regained some lost ground, draw ing strength from a bounce-back in the world economy, but

a full export recovery is still some way off due to a stronger yuan and cost inflation.

Evidence of this vulnerability w as found at the 108th Canton Fair in October,a bellwether for the trade climate. The num ber o f foreign buyers at the fair,which ran from October 15 to November 4, totaled 199,300, down 2.3 percent from the last session in April, said Canton Fair Deputy Secretary-General Liu Jianjun. The value of export deals hasn’t reached precrisis levels, he said.

As the United States pushes a wave of liquidity into global markets, concerns are grow ing that more speculative capital may find its way into China, adding fuel to the inflationary jitters and asset bubbles.

Housing prices in China’s 70 large and medium-sized cities grew a robust 8.6 percent year on year in October, despite an array of government measures to cool the property craze. Inflationary pressures have also stretched policymakers’ nerves as natural disasters drove food prices up earlier this year.

By printing more money, the United States w ill also force up global commodity prices,exacerbating inflation in China, said Jing Xuecheng, a senior econom ist at the China International Economic Relations Association.Crude oil futures for December delivery at the New York Mercantile Exchange closed at nearly $87 per barrel on November 5, the highest since October 2008.

The hot money is a two-edged sword. It increases net investments and feeds the capital markets w ith ample liquidity, said Guo Tianyong, Director of the Research Center of China’s Banking Industry under the Central University of Finance and Economics. But an abrupt w ithdrawal of the capital could prick the asset bubbles and deal a blow to the economy, he said.

An unw ise decision

The Fed’s move is understandable given the weak U.S. economy and bleak employment landscape, said Zhou Xiaochuan,Governor of the People’s Bank of China, the central bank.

“But the U.S. dollar is an international reserve currency w idely used in global trade and financial transactions,” he said. “So it might cause unintended side-effects to the global economy.”

“The question comes down to whether there is a problem w ith the international monetary system and whether there is a confl ict between the global and domestic role of the greenback,” Zhou said.

Chinese regulators w ill also keep a close eye on capital inflows and maintain the stability of the economy, he said.

The U.S. move is expected to spill over into the global economy, which may eventually result in a deluge of liquidity, said Cui Tiankai, China’s Vice Foreign M inister, at a press briefing on November 5.

When it makes these kinds of decisions,the Fed should take into account economies all over the world, not just its own, he said.

Vice Finance M inister Zhu Guangyao said the U.S. quantitative easing was a poor decision since it w ill send a shockwave throughout the emerging econom ies.

“The current U.S. economic situation is different from that at the height of the financial crisis,” he said. “The financial markets now do not lack capital, and the capital just lacks confidence for the real economy.”

As issuer of a major reserve currency, the United States must recognize its role and responsibility for the world economy, Zhu added.

Preparing the defenses

In response, China needs to step up a stringent handle over speculative capital inflows and maintain its financial health, said Yi Xianrong, a researcher w ith the Institute of Finance and Banking at the Chinese Academy of Social Sciences.

“Despite the Chinese Government’s regulatory controls, the hot money is likely to sneak in through companies overstating FDI or overinvoicing exports,” he said. “Hong Kong could also act as a springboard for capital seeking access to the mainland markets.”

Meanwhile, policymakers must siphon some liquidity out of the markets, said Shen M inggao, chief econom ist at Citigroup,Greater China. “Viable options include raising the reserve requirement ratio and issuing central bank bills.”

A number of emerging economies have already started building up their defenses.Thailand, for example, on October 12 announced a 15-percent w ithholding tax on capital gains and interest payments for bonds held by foreign investors. It also removed limits on overseas investment to encourage capital outflows. On November 2, India and Australia raised their interest rates by a quarter percentage point amid fears over inflation.

It would also be helpful if China could shrink the trade surplus and encourage more domestic capital to invest overseas, said Shen.

W ang Tao, chief econom ist at UBS Securities China, believes efforts are still needed to let air out of the real estate bubble.It is necessary to fight speculation in the housing market and curb land hoarding by state-owned property developers, he said.

Xia Bin, a member of the central bank’s monetary policy comm ittee, called for a reform to the international monetary system.“A healthy world economy requires a more stable and diversified currency mechanism,”he said.

THREAT TO RECOVERY:Fo reign buyers look at Chinese p roduc ts at the 108th Canton Fair held from Oc tober 15 to Novem ber 4. China’s exports have recovered, if on ly slightly, but uncertainties,inc lud ing a w eaker U.S.do llar, still loom large