Here comes the quantitative tightening… | FT Alphaville

Here comes the quantitative tightening…

A big hat tip to Sean Corrigan of Diapason Commodities for drawing our attention to the following Bloomberg report on Wednesday:

Nov. 24 `(Bloomberg) — Inflation pressure in China is rising on continous inflows because of increasing yuan appreciation expectations, Hu Xiaolian, the deputy governor of the People’s Bank of China, said in a statement posted on the central bank’s website today. The country will use quantitative and price tools to manage liquidity, Hu said.

Which seems to imply that (more) quantitative tightening (or QT) is coming to the People’s Republic of China very soon indeed.

And by QT we mean tightening by any means other than lifting interest rates directly.

As HSBC has already argued, this makes sense because it really is the only possible antidote to US quantitative easing for China — which under the existing trade framework ends up absorbing much of the US-created QE2 inflationary effect.

As Corrigan himself noted in a recent research report:

“Bigger yet is the threat posed by China’s inflationary outbreak. Although we derided its crude attempts to suppress prices and boost welfare payments – and while the market was briefly relieved that the PBoC did no more than hike reserve ratios for the umpteenth time – it does appear as if something a little more draconian may be coming down the track, possibly after the Central Economic Work Conference has discussed any such measures in three weeks’ time. Certainly, if we are to take the China Daily at its word, we should be reducing risk exposures where we can: –

“…The latest move to contain excess liquidity and the forceful measures that the central government has taken to stabilize prices show the determination of Chinese policymakers to fight inflation. Though these moves may not be enough to tame inflation once and for all, they are a good start before more aggressive actions become necessary to battle inflation that is unlikely to end anytime soon, as debt-laden rich countries keep flooding the world economy with their newly printed money.”

Well, if Ben can blame it all on Zhou, he is surely entitled to give a little of it back, but the main point is that the former’s indulgence in QE might just be about to run into the latter’s switch to QT.  We know which we think will carry more weight in setting commodity prices.”

All of which reawakens the old “whose fault is the financial crisis anyway?” debate. The fault of the surplus countries for funding deficit countries’ unproductive use of capital, or the deficit countries for spending beyond their means?

Bernanke et al, naturally, lay the blame on the surplus countries, which supposedly nurtured imbalances on purpose to gain trade advantages and kick-start or catch up on growth.

Which presumably explains why western central bankers are now so keen to up the ‘war on global imbalances’. After all, if China releases pent up and hoarded demand (and via that, growth) back into the global economy, they see it as a move which will help re-stimulate the West.

This point was very plainly presented in a speech by Axel Weber, the head of Germany’s Bundesbank, released by the BIS on Wednesday. As he noted:

Indeed, many of the persistent high current account positions that have emerged over the past decade are neither benign nor sustainable. The large U.S. deficit is due, first and foremost, to low national savings.

On the other hand, the current account surpluses of major emerging economies are, to a significant degree, the outcome of exchange rate policies that helped merchandise exports to grow. Rather than investing the financial surpluses domestically, China, in particular, continues to accumulate substantial foreign exchange reserves – mainly denominated in US dollars. Whilst this may possibly be not irrational from the surplus country’s point of view, it is partly responsible for making the global economy more vulnerable to adverse shocks.



Global imbalances still pose significant risks to the global economy. The unwinding of global imbalances is therefore one of the major challenges on the global policy agenda. It is a joint task of surplus and deficit, of advanced and emerging economies.

Of course, he shied away from blaming surplus countries outright — and rather focused on imbalances generally being the issue — since he himself represents a key surplus re-offender, Germany.

Nevertheless, from the above, it could easily be presumed that QE2 is really nothing more than a veiled threat, or even a purposefully crafted catalyst, to force China to release its dollar peg — and via that end the global imbalance disease at large. Not a Mexican stand-off, but rather a giant martingale by the Fed.

(Which, by the way, ties with the ‘QE2 no matter what!‘ attitude seemingly reflected by most FOMC members during their last meeting. It was also Dick Bove at Rochdale Securities’s theory regarding the real purpose of QE2.)

Of course, as Corrigan points out, if that is the case, it’s a very dangerous game for the Fed to be playing — not least in terms of inflationary consequences for the US, but inflationary consequences for the global economy at large.

As he explains, that’s because the unwinding of those surpluses will inevitably equal inflation, since it’s impossible to reshape America’s settings into production mode overnight:

Mr. Bernanke should also ask himself what would happen to American standards of living were the Chinese, Arabs, the Germans and the rest to take him at his word.

If this meant they were henceforth to use their surplus dollars directly for consumption, rather than channelling them toward the kind of unthinking vendor finance which has helped suppress world prices for so long, with money already so easy, his country would face an inflationary wave which its hollowed out industries could not easily expand to counter.

If America is being ‘impoverished’ under present policies it is because their settings encourage it to consume too much of its precious capital. Given this premise, we cannot expect that same capital to materialize instantly and to begin pouring out a plethora of cheap goods the moment the external tap is turned off.

Nor is it certain — as the argument implicitly assumes — that (outside the farm belt, at least) the extra spending would find its way into US cash registers instead of being shared out between the great producing nations themselves in a kind of BMW-for-oil-for-plasma-TV triangular trade.

And that, as HSBC has already noted, is why QT and not QE may actually be the real risk.

Related links:
Dick Bove on QE2 as a bank-less “financial war with China”
– FT Alphaville
Why QT, not QE, is the risk
– FT Alphaville
Capital controls: New front in currency wars – FT Alphaville