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Capital Markets Viewpoints

US Monetary Policy And Its Impact On China and Emerging Economies

by Simon Derrick


Despite diversifying its reserves over time, however, China has become increasingly concerned about its level of exposure to the United States in recent years. As long ago as April 2006, Yu Yongding of the Chinese Academy of Social Sciences told China Business News that “a large part of the reserves are being held in the form of US dollar assets. The assets are likely to lose their value if the US dollar weakens or inflation picks up in the United States. So we must make early preparations to prevent possible trouble.”4 These worries continued to build through the summer of 2007 until they finally became part of the official stance in March 2008, when Premier Wen Jiabao noted (at the end of the closing session of the National People’s Congress): “I am closely watching and feel deeply worried about the global economic situation, especially the US economy. What concerns me now is the continuous depreciation of the US dollar and when the dollar will hit bottom.”5

Reaction to the S&P Downgrade of US Government Debt 2011

These concerns had deepened substantially by August of 2011 following that summer’s debt ceiling crisis and the August 5 downgrade by Standard & Poor’s of US government debt. After a month of mounting warnings from officials, China’s anger over the news that the United States had finally been downgraded by S&P was palpable. The words from Xinhua, China’s official news agency, were stark enough. It called for “international supervision over the issue of US dollars” and for the United States to “live within its means.”6 It added: “The days when the debt-ridden Uncle Sam could leisurely squander unlimited overseas borrowing appeared to be numbered. … To cure its addiction to debts, the United States has to re-establish the common sense principle that one should live within its means.”7 It argued that China “has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets.”8

An article written by Yu Yongding for the Financial Times on August 4, 2011 (the morning of the downgrade), was even more telling. He argued: “If there is any lesson China can draw from the US debt ceiling crisis, it is that it must stop policies that result in further accumulation of foreign exchange reserves. Given that many large developed countries are simply printing money (and the recent rumors are that the US might return to quantitative easing) China must realize that it can no longer invest in the paper assets of the developed world. The People’s Bank of China must stop buying US dollars and allow the renminbi exchange rate to be decided by market forces as soon as possible. China should have done so a long time ago. There should be no more hesitating and dithering. To float the renminbi is not costless. However, its benefits for the Chinese economy will vastly offset those costs, while being favorable to the global economy as well.”9

China's frustrations with the Fed

Flash forward to 2013, and while the dominant narrative for the foreign exchange markets through the summer months might have been of the crisis that emerged in India, Indonesia, and Turkey, it was also clear that a number of other markets had benefited from an influx of international money from around July 10 onward following Ben Bernanke’s dovish comments at a conference sponsored by the National Bureau of Economic Research, Cambridge, Massachusetts (“…both the employment side and the inflation side are saying that we need to be more accommodating”10). China, in particular, appeared to have been a major beneficiary, forcing it to intervene aggressively to stop its currency appreciating. Foreign exchange reserve data for China showed that its holdings increased by US$163 billion (Thomson Reuters11) during the third quarter of the year, the fifth largest quarterly increase on record (only being beaten by Q2 2009, Q3 and Q4 2010, and Q1 2011). In other words, this was a return to the sort of conditions that prevailed during the height of the currency war in late 2010/early 2011 as expectations of the second round of QE, initiated in the fourth quarter of 2010, rose and were met.

China’s level of frustration at this turn of events was both clear to see and easy to understand when seen from its perspective. On the one hand, the Chinese authorities saw the Fed (whether by intention or not) sparking a fresh flow of money out of the US dollar and into their local markets. As China intervened to soak up these inflows, the authorities likely ended up recycling a substantial proportion of these fresh reserves back into US dollar deposits and US government and quasi-government securities (China is the biggest foreign holder of US Treasury bonds, worth a total of US$1.268 trillion as of August 2013 according to US Treasury data). However, having done so, they also found politicians in Washington flirting with the possibility of a default.

China’s Only Option: Currency Liberalization?

The answer to the Chinese authorities’ problem remains as clear as ever. China would probably love to move as much of its reserves out of the US dollar as possible. However, the sheer size of its reserves makes any meaningful move almost impossible to execute other than over the very longest of terms. Therefore the only practicable way that China can break the cycle in the foreseeable future is for it to liberalize its currency regime in order to reduce its need to accumulate reserves.

All the signs are that this is exactly what China is planning. While it seems clear that the pace of liberalization will be measured, and that the process will be flexible enough to allow the government to reimpose restraints should there be large capital movements into or out of China, it is also clear that the process is under way. In May of 2013 the State Council announced in a statement that the government would outline a plan for full convertibility of the renminbi (Chinese yuan) by the end of the year,12 while in September the Council announced that it planned to use the China (Shanghai) Pilot Free Trade Zone as a test bed for a convertible renminbi and liberalized interest rates according to a statement posted to the website.13

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Further reading


  • Authers, John. Europe’s Financial Crisis: A Short Guide to How the Euro Fell Into Crisis and the Consequences for the World. Upper Saddle River, NJ: Pearson Education/FT Press, 2013.
  • Davis, Norman. Vanished Kingdoms: The Rise and Fall of States and Nations. New York: Penguin, 2012.
  • McLean, Bethany, and Joe Nocera. All the Devils Are Here: The Hidden History of the Financial Crisis. New York: Portfolio/Penguin, 2010.



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