China’s concern over US monetary expansion

As the US effectively prints more money, Chinese officials are expressing concern over the impact that this will have on their economy

As in the UK, the US has engaged in ‘quantitative easing’, which essentially boils down to printing money in order to purchase bonds and inject liquidity into the private sector. The quantity theory of money suggests that an increase in the money supply, such as this, will lead to an increase in the general level of prices (other things remaining equal). Chinese officials believe that inflation is therefore likely to rise in the US, causing the value of the dollar to fall (since one dollar will purchase fewer goods).

Why might this be of concern to the Chinese, you might ask? China holds a significant reserve of US dollars, mainly as a result of its large trade surplus from high levels of exports to the US in particular; indeed, its reserves are estimated to be in the region of $2trillion. To allow its reserves to maintain significant purchasing power, the Chinese may consider converting their reserves into Euros and other hard currencies. This would weaken the dollar’s position as the reserve currency of the world. Alternatively, they would consider purchasing gold. However, one Chinese official was quoted in an article in Telegraph as saying that “Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets.”

This is a particularly good example of the effects of increased interconnectedness, especially in terms of financial and commodity markets. The overall effects, however, depend, I think, on the US Federal Reserve’s ability to reign in the current increase in the money supply once the liquidity situation improves. If the money supply can essentially be contracted, once the velocity of money starts to rise again, then inflation, such as the Chinese suggest will occur, is less likely.