Business

China should be cautious about the Fed's QE2

By Zheng Liansheng (China Daily)
Updated: 2010-11-12 11:00

BEIJING - The Federal Reserve recently announced that it would maintain interest rates and implement the second round of quantitative easing (QE2) monetary policy.

These will affect China, which would face greater inflationary pressures as QE2 would result in more serious global liquidity and imported inflation. It would also raise inflationary expectations.

Meanwhile, since the capital account has not been fully opened, the inflow of more hot money would increase funds outstanding for foreign exchange, speed up money supply and increase inflationary pressures. What's worse, the independency of monetary policy may be jeopardized.

The possible acceleration of inflow of hot money would pose more pressures on assets prices, especially that of stock and real estate market. China should be cautious of asset bubbles.

Recently, the United States has been tougher on the yuan's appreciation. It even passed Currency Reform for Fair Trade Act, which allows the US to enforce anti-dumping and countervailing duty against trade partners deemed to be manipulating their currencies. Besides the US and countries in Europe, some emerging economies such as India and Brazil also advocate the appreciation of yuan.

China needs a steady exit from stimulus policy. On one hand, budget deficit has become obvious and the government should optimize the structure of national revenues and expenditures; on the other, the negative impact of continuous loose monetary policy has been revealed.

A stable monetary policy is needed to curb inflationary expectation, asset bubbles and even systematic risks.

China also needs to adjust its economic structure and balance internal and external economy.

First, the government should expand domestic demand, reduce savings rate, narrow the saving-investment gap, decrease trade surplus and diversify its investment on foreign exchange reserves.

Second, China should upgrade its industry structure by combining the upgrade of traditional industries with development of emerging industries.

Third, China needs to further reform its price structures, promote the marketization of interest rate, yuan exchange and taxation systems.

Fourth, it must take necessary measures to cope with possible risks, especially with the US debt.

The sluggish economy and high unemployment rates in the US have brought on QE2. Despite of its diminishing marginal effect, QE2 is the only choice for the US.

Due to the economic downturn in the US, consumer credit has a low growth. The real estate market has lost its pull while profits of financial institutes have not recovered. As well, emerging industries and manufacturers could not lead the US economy into fast development either.

On the other, the low price level further eases the Fed's concerns.

Future policies of the Fed depend on the effects of QE2. It would periodically evaluate the plan of bond buying and asset acquisition, and make adjustments when necessary.

Since there is no room to lower interest rates, QE remains the only measure to deal with the unsuccessful economic revival and high unemployment rate. Therefore, QE is expected to become the norm in the future.

But QE2 can in the short term increase market confidence.

The US dollar may come under more pressure while currencies in emerging economies would appreciate in a short term. The conflicts between the US dollar and other currencies would probably be fiercer.

QE2 may suspend the exit of global stimulus policies. Continuous QE may lead to worsening inflation and asset bubbles in emerging markets. And QE's huge internal risks should not be neglected either.

The author is a researcher from the Chinese Academy of Social Sciences in Beijing.

China Daily