Is Ben Bernanke the New Chairman of China’s Exchange Rate Policy?

The US and the World want China to increase the value of its currency. China does not want to do that now. And China is too powerful now to be told what to do. But maybe the chairman of the US Federal Reserve has now more impact on China’s exchange rate policy than any other person in the world.

 

The US Federal Reserve introduces QE2 (Quantitative Easing number 2). It is QE2 because there was a QE1 before. Now, QE3 could be an option.

 

The Fed says that QE is not the same as printing money. They say this are measures that can be unwind. Among the economists and observers, there is no agreement on this.

 

QE means that the Fed creates new money to buy US treasuries that are issued to finance the US public deficit. I think that everybody agrees that the US public deficit is not healthy and should be brought down.

 

The Japanese Lesson for China

 

Another major economic point is the trade imbalance between the US and China. China exports much more to the US than the US exports to China. But that is not all. Chinese manufacturers also kick butt of European and US manufacturers in the rest of Asia, Africa and Latin America.

 

A country like China that exports a lot gets the capital to keep its exchange rate artificial low. That comes at a cost. It comes at a discount since when eventually the Chinese currency appreciates, all those Dollars become less worth to China. But to keep an export fuelled economy going, a lower currency is maybe worth that cost.

 

This seems to be the case for China. China has also seen what happened to Japan after they departed from their policy of a weak currency. Japan had a massive bubble and a lost decade with deflation during the nineties. China cannot afford that since a too low economic growth in China would cause social unrest.

 

 

Exporting Inflation is the Secret Weapon of the US

 

Thus China sticks to its “weak” currency policy to the unhappiness of the US. What can the US do? It does not have the power to force China directly to do what the US wants.

 

Now here is something that they could do. It could be intentionally or not. A result of QE or printing money is inflation. Inflation does not stay limited to the country that prints the money but is also exported to the country that holds a lot of that currency. And inflation starts with food prices.

 

Now in the US and Europe, the average person only spend a small percentage of its income on food. In China, people may spend 50% of more of their income on food. Can you see what rising food prices do to the average person in China?

 

 

Is China’s Only Defense to Do What Is Good For China

 

What can China do to protect itself from imported inflation? It can reduce the credit in the domestic economy. But that hurts the economic growth. And a certain level of growth is needed to keep the country stable. What else can it do? What about increasing the value of its currency, stimulating domestic demand and relying less on exports…

 

This is the economic direction that the US and many economists around the world would like that China is taking. It is not an easy route for China with risks of instability etcetera. And the Chinese leadership understands the issues very well and may see lots of other problems with it. But the rest of the world would appreciate it when China moves in that direction.

 

Thus QE could actually be the best tool that the US has to encourage China to move towards higher exchange rates, less export dependent and more domestic demand. Is this tool used intentionally and is Ben Bernanke now deciding the Chinese economic policy…. or is it just a nice bonus for an almost bankrupt country that does not have the political will to tighten the belt.

 

What do you think?

 

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