Friday, September 16, 2011


There is a story out on the Daily Telegraph which has a lot of bond traders talking. Ambrose Evans-Pritchard reports that China is planning to liquidate some Treasury holdings and buy physical assets, stocks, and basically anything else that isn’t U.S. bonds. Prichard makes the claim that China views the Fed’s quantitative easing program as a "stealth default." I don’t believe that is true at all. I know that China will say things like "stealth default" in public. But to assume that is what their economic officials actually believe is plain insulting to China. It implies that they don’t understand monetary theory, the transmission mechanism between rates and money growth, or the U.S. growth/inflation situation. I think they understand all too well.

Indeed, you can tell so from China’s own monetary strategy. They have been “printing” yuan to buy dollars for years, and proportionately in much larger amounts than any QE program. There is very little difference between rapidly expanding the money base via the foreign currency markets vs. doing so via the interest rate complex. Either way, you’ve expanded the money base. In fact, even an elementary understanding of monetary theory would lead one to know that extremely easy money in a rapidly growing country is much more likely to be inflationary (i.e., China) than the same policy in a contracting and/or stagnant economy (U.S.)

There are several more of Prichard’s claims that don’t pass the basic smell test (if China thinks that our currency is getting trashed, why buy our stocks?). Here is the reality. China knows that their foreign currency peg is creating problems for themselves. One of those problems is a reliance on the U.S. dollar, but there are others. China’s economic minds are no doubt worried that a sudden decoupling with the dollar is risky, and therefore they’d rather slowly loosen the peg. But it will be the loosening of the peg that causes Chinese demand for U.S. Treasuries to decline. Not the bogey man of sudden liquidation.