CNBC Guest Blog

Published: Monday, 16 Nov 2009 | 12:45 PM ET

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Andrew Busch
Global Finance Strategist
BMO Financial Group

Over the weekend, China's chief banking regulator sharply criticized the US Federal Reserve and the monetary policy of the United States. Liu Mingkan said that the U.S. Federal Reserve's promise to keep U.S. interest rates at extraordinarily low levels for an extended period "has already led to a massive U.S. dollar carry trade and massive speculation."

He said that the weak U.S. dollar and low U.S. interest rates are creating "unavoidable risks for the recovery of the global economy, especially emerging economies" and that the situation is "seriously impacting global asset prices and encouraging speculation in stock and property markets" according to the WSJ.

On the offensive, the head of the IMF said the Chinese yuan needs to strengthen to ease global imbalances. Dominique Strauss-Kahn said that Beijing needs to implement a stronger yuan and increase domestic consumption to achieve this goal.

China's Ministry of Commerce chimed in by saying that international pressure for appreciation of the yuan was "not fair" and is not conducive to global economic recovery. Ministry spokesman Yao Jian said, "It's necessary for us to provide a stable and predictable environment in terms of macro-economic and exchange rate policies."

By looking at the NDF forwards, the FX markets are anticipating about a 3.6% appreciation of the yuan over the next 12 months. The Bank of China is noticing that demand for dollar loans in China is climbing and deposits for the US dollar are declining, reflecting increasing speculation that the yuan will resume appreciation.

Bank of China's Shi Lei said, "No one wants to hold dollars in their hands if they can exchange them for yuan and benefit from the potential appreciation. Companies prefer to borrow dollars now to meet overseas payments with a view to repaying the loans once the yuan has risen."

As I wrote last week, the world is beginning to wake up to the fact the Chinese have increased their competitive trade position via the link between the US dollar and the yuan. We see this in the commentary by finance ministers and increase in filings of trade suits by countries to the WTO against China. However, the lack of any specific commentary from the APEC meeting underscores the inability of the Far East/United States to force China to an agreement.

While trade imbalances are not something I believe are a concern, global reserve imbalances are a different story. The massive increase in Chinese holdings of US dollars and US Treasury securities has two big potential problems. One is the United States government dependence on a foreign entity for loans. Two is the facilitation of borrowing to the United States that perpetuates a belief that massive and ever increasing borrowing can continue without a cost. Both contribute to a dangerous situation should a sudden shift in the structure occur.

As you may have read, the Chinese grilled OMB director Peter Orzag on the impact that the health care bill would have on the US fiscal position. As I have warned, the passing of the current bill by Congress is a negative for the US dollar and may trigger a re-evaluation of Chinese US Treasury purchases.

• Washington Not Trying to Contain China: Obama

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Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him here and you can follow him on Twitter at http://twitter.com/abusch .

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