U.S. Should Avoid Third Round of Quantitative Easing

Summary: Once QE3 is launched, the dollar will surely depreciate, and the trillions of U.S. debt held by China will shrink. In addition, printing money on a large scale will inevitably lead to global inflation, which will trap China’s macroeconomic policy environment in a deeper dilemma.

Under the shadow of America’s sovereign debt crisis, U.S. Vice President Biden visited China, and he definitely talked about the U.S. treasury problem. However, the RMB exchange rate issue will still be one of the main topics of Biden’s visit to China. To this end, China needs to express its own opinions on and requirements for America’s current economic problems.

Biden claimed, when accepting China’s media interview, that the Obama administration was firmly committed to maintaining America’s economic foundation and ensuring the safety, liquidity and value of U.S. government bonds for all its investors. He expressed that the fundamental strengths of America’s economy are still there, and that those who think that the U.S. is in decline are wrong. Biden also expressed hope that China will continue buying U.S. debt and that if Chinese companies invest overseas, they would first look to the U.S.

Since the U.S. debt crisis, China strongly urged the U.S. to take responsible and practical measures but, relatively speaking, China shows trust in U.S. debt. Of course, the situation is very frustrating.

Although the U.S. economy may be recovering, there are uncertain factors. Nevertheless, the U.S. economic foundation is still the world’s first, and on a global scale is good. What’s more important is that China’s current economic development model determines that China has large foreign exchange reserves, and it cannot change this model in the short run, which will increase foreign exchange reserves. In order to increase the value of foreign exchange reserves, China will inevitably invest much of it overseas. However, no matter how diversified China’s foreign exchange reserves are, and no matter how we measure them quantitatively or qualitatively, U.S. debt will always be the first choice for overseas investment of China’s foreign exchange reserves. China holds nearly $3.2 trillion in foreign exchange reserves, and over $1.1 trillion in U.S. debt. China increased its holdings of U.S. debt $5.7 billion in June, the third increase in three consecutive months. As for investment in the U.S., as long as the U.S. reduces the limit, China is very interested.

Therefore, fulfilling the mission of “persuading” China to continue buying U.S. debt was easy for Biden to accomplish during his visit to China.

If Biden didn’t want to ask China for too much on the U.S. debt issue, it was therefore understandable that, for balance, he raised the issue of the RMB exchange rate.

Since reform, the RMB’s value has increased a lot. Before the 16th of this month, the RMB’s exchange rate hit its highest rate for five days in a row. On the one hand, it’s the result of trade surplus with China; on the other hand, it’s China’s inflation situation. Thus, a certain degree of appreciation of the RMB is the consensus of both China and the U.S. However, the rate of appreciation is limited, and it’s not possible to reach agreement as some Americans had hoped.

Products made in China make up only 1.9 percent of U.S. household consumption, which means that the view of some Americans, who thought that the RMB’s appreciation would create more space in the U.S. market for products made in the U.S., is not reliable. In fact, a majority of interests in U.S. imported products that are made in China went to American employees and companies’ pockets; the influence of the RMB’s appreciation on America’s manufacturers’ competitive strength is quite limited. What’s more important is that if the RMB appreciates sharply, small- and medium-sized enterprises that assume major export tasks will be seriously impacted, and China’s current economic structure cannot be changed in the short run, so China’s economy will be heavily affected. In addition, fundamentally, China’s current huge foreign exchange reserves actually include suppressed labor costs and overlook environmental costs and some unreasonable system costs. If all of these can be changed, and cost, trade and exchange rate released and reflected, will the RMB exchange rate appreciate or depreciate? It’s hard to say.

China’s demand from the U.S. is simple. As a matter of fact, China is actually not very worried about S&P’s downgrade of the U.S. sovereign credit rating; it’s worried that the U.S. should try to avoid a third round of quantitative easing (QE3).

Since the U.S. dollar still maintains its core status in the world’s currency system, the U.S. government should take responsibility. Once QE3 is launched, the dollar will surely depreciate, and the trillions of U.S. debt held by China will shrink. In addition, printing money on a large scale will inevitably lead to global inflation, which will trap China’s macroeconomic policy environment in a deeper dilemma. Therefore, it is imperative that we demand that the U.S. not put forward a new round of quantitative easing.

In addition, if the U.S. dollar depreciates irresponsibly, China will not only stop buying U.S. debt, but will also gradually reduce the U.S. debt it currently holds. This is not in America’s interest, nor does it conform to the vice president’s mission in China.