China’s Clear Warning

by Crocker on May 7, 2009, 5:35 am

in Economics,Politics

I’ve expressed my misgivings about ‘quantitative easing’ by central banks, chiefly by the U.S. Federal Reserve and the Bank of England. ‘Quantitative easing’ is a cute term for printing money. And the presses have been working overtime, particularly in the U.S. and the UK. Our money supply has more than doubled since last fall and the Fed has admitted that it’s ‘monetizing’ our national debt, in the trillions of dollars.

What happens when you print lots of fiat currency? You get inflation – eventually. While the slack economy is causing a temporary deflation – even though oil prices are rising again – inflation is inevitable when money begins changing hands again at a normal rate. Moreover, a country awash in fiat money creates perverse economic incentives, as it did with the subprime mortgage market.

So, we’ve been a country that’s run massive deficits and borrowed the money to finance it. And one must ask a logical question: what happens when no one will lend us more money – particularly if they think we’re destroying the world’s monetary system at the same time? Answer: they don’t lend us any more money and go into self-preservation mode.

And look at China, which has been doing a lot of lending and is now rethinking its portfolio. From the UK Telegraph:

China has given its clearest warning to date that emergency monetary stimulus by Western governments risks setting off worldwide inflation and undermining global bond markets.

“A policy mistake made by some major central bank may bring inflation risks to the whole world,” said the People’s Central Bank in its quarterly report.

“As more and more economies are adopting unconventional monetary policies, such as quantitative easing (QE), major currencies’ devaluation risks may rise,” it said. The bank fears a “big consolidation” in the bond markets, clearly anxious that interest yields will surge as western states try to exit their QE experiment.

Simon Derrick, currency chief at the Bank of New York Mellon, said the report is the latest sign that China is losing patience with the US and aims to diversify part its $1.95 trillion (£1.3 trillion) foreign reserves away from US Treasuries and other dollar securities.

“There is a significant shift taking place in China. They are concerned about the stability of the global financial system so they are not going to sell US bonds they already have. But they are still accumulating $40bn of fresh reserves each month, and they are going to be much more careful where they invest it,” he said.

Hans Redeker, head of currencies at BNP Paribas, said China is switching into hard assets. “They want to buy production rights to raw materials and gain access to resources such as oil, water, and metals. They know they can’t keep buying bonds,” he said.

But back to elementary economics and inflation. People invest in ‘hard’ assets – like metals and other commodities – when they fear the stability of the world’s monetary system. That’s what happening now – as we continue to print and spend more and more money.

The six dumbest words in the English language are, ‘this time it will be different’. We’re behaving as if we can escape the inevitable result of our actions, as if this time will be different.

But it won’t – and it can’t.

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