Streetwise Professor

November 16, 2009

Pot, Meet Kettle

Filed under: Economics,Politics — The Professor @ 10:03 pm

China’s chief banking regulator excoriated the United States Federal Reserve for its extremely lax monetary policy:

The US Federal Reserve is fuelling “speculative investments” and endangering global recovery through loose monetary policy, a senior Chinese official warned on Sunday just hours before President Barack Obama arrived in China for his first visit.

Liu Mingkang, China’s chief banking regulator, said that the combination of a weak dollar and low interest rates had encouraged a  “huge carry trade” that was having a “massive impact on global asset prices”.

The comments came as China and the US sparred at the Asia Pacific Economic Co-operation summit in Singapore over exchange rate policies amid rising international criticism that China’s currency is undervalued.

Mr Liu’s unusually blunt remarks underscore how China – the largest US creditor because of its massive holdings of Treasury bonds – has become a trenchant critic of monetary and fiscal policy in the US.

Since the start of the financial crisis, Chinese officials have issued a number of warnings that the US should not inflate away its mounting debt burden. Before these latest comments, however, Beijing had generally been most critical of US fiscal policy, urging Washington to spend less.

But speaking at a conference in Beijing, Mr Liu said the Fed’s policy of maintaining low interest rates together with the weak dollar posed a threat to the global economic recovery.

“[It] is boosting speculative investment in stock and property markets and will pose new, real and insurmountable risks to the global recovery and particularly to the recovery in emerging markets,” said Mr Liu, who is chairman of the  China Banking Regulatory Commission.

“The situation has already encouraged a huge dollar carry trade and had a massive impact on global asset prices,” he added.

As the next sentence in the FT points out, however, China’s monetary policy is not exactly a model of probity:

However, Mr Liu’s criticism of the Fed comes as China’s own monetary policy is attracting growing scrutiny at home and abroad. Critics say the massive expansion in bank loans this year could cause asset price bubbles and inflation.

Qin Xiao, chairman of China Merchants Bank, last month said China “urgently” needed to tighten monetary policy to avoid stock and property market bubbles.

Evans-Pritchard in the Telegraph recapitulates some of the gruesome details:

The reality is that much of Beijing’s $600bn stimulus has been spent building yet more plant and infrastructure so that China can ship yet more goods, or has leaked into property and stocks.

Credit has exploded. Allocated by Maoist bosses for political purposes, it has become absurd. China is rolling as much steel as the next eight producers combined. It is churning more cement than the rest of the world. Fixed investment is up 53pc this year. Once you know that Hunan authorities have torn down two miles of modern flyway so that they can soak up stimulus by building it again, or that the newly-built city of Ordos is sitting empty in Inner Mongolia, you know what must come next.

Pivot Asset Management said lending has touched 140pc of GDP, “well beyond” levels that have led to crises in the past. With the revolution’s 60th birthday out of the way, the central bank has begun to tighten. New yuan loans halved in October. So be careful. Pivot said a hard-landing in China could prove as traumatic for world markets as the US sub-prime crash.

The world economy is still skating on thin ice. The West is sated with debt, the East with plant. The crisis has been contained (or masked) by zero rates and a fiscal blast, trashing sovereign balance sheets. But the core problem remains. The Anglo-sphere and Club Med are tightening belts, yet Asia is not adding enough demand to compensate. It is adding supply.

My view is that markets are still in denial about the structural wreckage of the credit bubble. There are two more boils to lance: China’s investment bubble; and Europe’s banking cover-up. I fear that only then can we clear the rubble and, very slowly, start a fresh cycle.

Both the US Fed’s policy and that of the Chinese make me cringe.  The Fed’s path, and US fiscal policy, are unsustainable.  Yes, the Fed may have a plan to tighten, but I seriously doubt that its commitment to implement this plan is credible, especially if the US government debt continues to explode.  This worries the Chinese, because of their accumulation of more than 2 trillion dollars in dollar-denominated assets.  Point taken.

But the Chinese stimulus policy is also clearly unsustainable as well, and demonstrably wasteful (e.g., building highways, tearing them down, building them again).  Indeed, the resource misallocations associated with the Chinese credit boom are palpably more acute than those that resulted from the Fed bubble of the mid-2000s.  Yes, we built too many houses and strip malls.  But the Chinese, it appears, are building too much of everything.  It is hard to imagine this ending with a smooth landing, rather than a crash.

The proper way to respond to distortions is not to create new ones.  As I argued in “The Michael Jackson Economy,” huge steroid injections can mask temporarily the adverse symptoms of previous policy-induced problems (arising, for instance, from the Chinese currency peg, US monetary policy, and perverse housing and accounting policies), but they tend to make the ultimate dislocations even more acute.  The mania for planning and controlling huge open economies will inevitably founder on their intricate complexity.  Canute was smart enough to know that he could not control the tides.  The Chinese and American monetary and fiscal authorities are victim of the conceit that they can control the economic tides, and we will pay the price when their conceit is revealed to be just that.

In sum, neither China nor the US have any business lecturing anybody, least of all each other.  Both are engaged in unsustainable policies intended to address short run (albeit severe) economic problems.  All they will succeed in doing is transforming short term problems into long term ones, into Japan writ large.

Print Friendly, PDF & Email


  1. As I promised a while ago, here’s a link to

    Russia’s Sisyphean Loop:
    The Eternal Return to the Future?

    Comment by Sublime Oblivion — November 17, 2009 @ 8:33 am

  2. Before criticizing anything, China needs to fix its artificially undervalued currency.

    Comment by A. Dawn — November 17, 2009 @ 12:30 pm

  3. “but they tend to make the ultimate dislocations even more acute.” — makes me shudder. Its a bad time to be young at a time of recession..err depression!
    Isn’t there any reset button in the system? Since most of the money is electronic cant we just do a “system recovery” like when windows crashes 😀 Forget each other’s debt and start with a fresh slate and be productive , with an agreement to restart whenever we crash…

    Comment by Surya — November 18, 2009 @ 1:02 am

  4. Introducing a reset button will make it into a repeated game with new perverse incentives.

    I for one am disappointed by the Great Recession. I was eagerly awaiting mass riots, martial law, and fiery Communist and far-right rhetoric taking control of the airways and internets. There’s still hope though as SWP keeps pointing out.

    Comment by Sublime Oblivion — November 18, 2009 @ 2:22 am

  5. Perhaps the unemployment cheques are preventing this from happening. The clever politicos in Washington have extended them just to avoid the above scenario. It makes me wonder…how do people drop off the unemployment payroll when they get a job? Does it happen automatically? Or does the person have to manually report? If so, why would anyone report, when you can benefit from the govt. cheque and a part time job at the same time…. What stops anyone from gaming the system, especially when times are tough?

    Comment by Surya — November 18, 2009 @ 2:35 am

  6. “What stops anyone from gaming the system, especially when times are tough?”

    The possibility of being arrested and convicted of fraud, I expect.

    Comment by rkka — November 18, 2009 @ 6:59 am

RSS feed for comments on this post. TrackBack URI

Leave a comment

Powered by WordPress