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Busch: China Is the Future of the US

After the less than satisfying G20 meetings, the latest newsflow out of China is centered on what to do about inflation and how to counteract QE2. To wit:

  • People’s Bank of China’s Prof Wang said, “The growth of prices has accelerated since September mainly because of intensive hot money inflows because of yuan appreciation and new quantitative easing measures by the U.S....It's an urgent job for the central bank to tighten up liquidity and it needs new policy tools to do so." Shanghai Securities News.
  • China Investment Corporation’s Hong Kong chairman Lawrence Lau said China should stop purchasing US Treasuries but should continue to buy US dollar assets and warned of the impact of a simultaneous sell-down of Treasuries by holders such as China, Hong Kong, Japan and Korea.
  • PBOC adviser Zhou Qiren and member of Monetary Policy committee said that China should solve its domestic inflation problem by allowing the yuan to appreciate more to encourage Chinese people to spend abroad. He noted a perception among Chinese that the yuan is still too cheap.

To me, the intriguing development is not only the Chinese response to inflation, but also that they are responding to potential inflation from QE2.

This makes perfect sense given that via the US dollar-Chinese yuanlink, China effectively has the same monetary policy of the United States.

Therefore, the questions before the Chinese are how long can they sterilize the flow of US dollars into yuan, how high will they raise reserve requirement and how much more regulatory tightening will be done to offset inflation? With inflation jumping over 4% for a single month, the Chinese understand they must solve this issue above all others.

China
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China

This means they will risk a slow down in growth to meet their objectives.

The challenge for the Chinese is that they have never had to face domestic stimulation on this scale from an outside force.

Just like the Fed, the Chinese central bankers appear to have the same mandates of employment and inflation. Just like the Fed, the PBOC will have to balance these in a global environment that will influence their decisions.

Just like the Fed, the more policy issues a central bank has to deal with the larger the margin for error.

Unlike the Fed, the PBOC must to deal with these issues now. The Federal Reserve should be watching and taking notes.


Andrew B. BuschDirector, Global Currency and Public Policy 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 hereand you can follow him on Twitter at http://twitter.com/abusch.