China: Doubts And Opportunity Following Bernanke’s Announcement

Just as China barged rudely in on the race for the White House, the actions of the US Federal Reserve unwittingly strike back at Beijing’s economic policy. Last month Fed president Ben Bernanke decided to inject $40 billion per month through the scheduled acquisition of mortgage debt from the market. Coupled with the demand for long-term Treasury bonds, the operation will pump $85 billion into the market each month. The move is an attempt at bringing down unemployment by spreading liquidity. Despite being technically different from the instruments used during the low point of the economic crisis in 2009-2010, it will nevertheless have an impact on China. Beijing is in fact fearful that Washington’s latest quantitative easing will have a damaging effect on its economy, that QE3 will produce setbacks like GE2. That which China dreads – and has thus far allowed to be discussed by important economists without actually making a declaration of its own –is a danger that has already been identified, a three-headed-monster. The first is inflationary pressure. Enormous amounts of money entering international circulation could easily lead to an increase in the cost of raw materials, and China is the world’s biggest importer of minerals and food products. An increase in their cost would have a cascading effect on all of China’s consumption. After years of price controls through monetary policy, the shadow of inflation has been brought under control, but has not yet fully vanished. Additionally, speculation could drive large quantities of capital towards China, attracted by the higher interest rates and heating up the economy, pushing money towards the construction sector. Regulation of construction sector costs, tied to the fear of an implosion of the real estate bubble, have locked the Chinese government in a fierce internal struggle that produced valid results that could easily be wiped out by more profitable new investments. There is, however, a more strictly political aspect to China’s concern. The US move is undoubtedly unilateral, borne of Washington’s internal problems, and the consequences will batter China without ever giving it the chance to negotiate. The dollar keeps its role intact and perpetuates the subordination of the renminbi, deferring its convertibility to yet another distant horizon. And yet, QE3 may still provide some advantages for today’s China. Its current circumstances are different from 2009, when its recovery appeared solid and the faltering West was a boost for its national pride. China today is heading towards a figure of more than 7% growth, which is nonetheless the lowest in 22 years. Profit and demand levels are dropping while production costs go up. More liquidity, even if it comes from the other side of the Pacific, could breathe life into the system, boosting the Shanghai and Shenzen stock exchanges. Often branded as being risky, the Chinese markets would avoid paying a premium for their indecision. In other words, more currency will stimulate demand and lower the presumed risk.  Commodities reserves would be replenished as prices go up, in a move that mirrors the last 18 months, when a nonexistent lowering of prices was eagerly awaited, causing a drop in purchases. Today the PMI (Purchasing Managers Index, an important indicator for the health of the economy) is registering less than 50, in other words below the threshold of regular purchases, where optimism and pessimism for the future are at odds. Equally positive for China would be an increase in American demand. Beijing’s exports would register immediate results as it limps along by a very modest growth rate of 2.7% per year (data for August, yoy), a far cry from the stunning growth rates China has registered in the past. The Chinese government understands its needs well, and just days after Bernanke’s announcement a similar action was undertaken in Beijing, and injection of $58 billion that immediately lowered interest rates by 100 base points. It is a confirmation that the entire economy needs a jolt. It could have come from Washington, but that would have collateral effects that China cannot accept: it was in dollars and it was issued by another country. For now, political competence has prevailed, understandable in a time of elections and people’s congress. When the tensions have been eased, a more realistic and results-oriented climate will likely prevail, where money is not judged by its color but by the results it produces.