China Could Be A Big Winner If The Fed Embarks On QE3

After rather dovish comments we read from the Fed minutes, the expectation for another round of large-scale asset purchase programme has increased despite incoming data from the US improving somewhat.

Investors who have been addicted to global stimulus will certainly welcome another round of asset purchase.  Yet among those who hope for the third round of quantitative easing, there is one quite unexpected one.

Someone from China.

This is the most surprising comment we came across in recent days.  After all, quantitative easing seems to have got more blames from China than praises in the past few years, as it triggered too much capital inflow since the recovery.  With large trade surplus and massive inflow, the desire of the People’s Bank of China (PBOC) to prevent Chinese Yuan from appreciating too quickly forced PBOC to create more money.  As a result, Ben Bernanke got the blame from China for indirectly fuelling inflation.

As we have noticed since late last year, however, the money flows pattern has changed in a way that it is no longer forcing PBOC to create money.  Balance sheet expansion of the People’s Bank of China has already stopped as money outflow reduces the need for foreign exchange intervention.  PBOC have some tools to offset outflow for a while, such as cutting RRR or reverse repo, but not indefinitely, thus we now believe that sooner or later PBOC will need to engage in some sort of quantitative easing too.

The idea that PBOC can go out can buy securities like government bonds, however, has got very little attention, probably as the relationship between money creation and inflow is not well understood.  We also believe that the government and the central bank are hesitant in provide aggressive stimulus since the previous massive stimulus was viewed that it was a mistake.  So while we believe PBOC will eventually be forced to “print money”, PBOC will only do so very reluctantly (perhaps after things get really bad).

So here comes Peng Wensheng of China International Capital Corporation (CICC), a Chinese investment bank.  He suggests that “QE3 will do more good than harm to China” as QE3 can hopefully encourage some capital inflow once again:

QE3 will help stabilise China’s external demand… We are inclined to believe that QE should help stabilise the US’s domestic demand in the face of fiscal tightening. In this sense, QE3 will help prevent China’s export growth from falling sharply further.

We believe the impact of QE3 on China’s inflationary pressure will be significantly milder than QE1 and QE2. When the US introduced QE2, China’s economy was growing rapidly, investment growth was at its peak and inflationary pressure was rising… As a result, QE2 led to significant imported inflationary pressure, especially through the rise of commodity prices. In contrast, at present China’s economic growth has slowed significantly, real estate investment growth has fallen sharply, enterprises are destocking and PPI is contracting. Though QE3 may still spur demand for commodities (including speculative demand), demand from China has been much more moderate.

In addition, China is now facing relatively tight liquidity conditions due to net capital outflows, and this is very different from the time of QE2, when China recorded significant capital inflows… If QE3 puts downward pressure on the US dollar, capital may flow into emerging market countries, reducing the net outflows from China and easing domestic liquidity conditions. QE3 may also have a positive effect on risk appetite in China.

In other words, it is hoped that QE3 will push the dollar down and encourage capital flow into China, so that PBOC can expand its balance sheet by accumulating foreign assets, which is the old way of doing things, rather than having PBOC initiating the “dirty work” of quantitative easing by themselves.  A related effect, of course, is that if US dollar is weakened, exports might recover as the Chinese Yuan is pegged wit the US dollar.  It makes sense, although we cannot be sure if QE3 will surely have the intended effect of encouraging capital flow into China and/or stimulating exports.

This article originally appeared here: An unexpected proponent of QE3
Also sprach Analyst – World & China Economy, Global Finance, Real Estate

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