22 August 2019
The strength of the yuan has been largely built on a weak US dollar. The end of QE will affect the globalization of the Chinese currency. Photo: HKEJ
The strength of the yuan has been largely built on a weak US dollar. The end of QE will affect the globalization of the Chinese currency. Photo: HKEJ

How China should adjust to post-QE era

It’s official. The United States has finally quit its quantitative easing (QE) program after five years.

The end of the ultra-loose credit loosening policy will greatly influence the global market, with China, the world’s second largest economy, bearing the brunt of the policy change.

In the post-QE era, the biggest challenge to China is a drain on liquidity.

Although the US Federal Reserve has pledged to keep interest rates low for a long time, the end of the QE policy means global capital will flow from emerging markets to the US for higher return.

Experience has shown that whenever the US tightens its credit policy, emerging markets experience capital outflows associated with depreciation of their currencies and asset price declines.

China has seen this trend. In September, the country’s exports unexpectedly rose 15.3 percent year on year, beating the previous month’s 9.9 percent, thanks to high-value items and shipments to Hong Kong.

This showed that speculative money, on expectation the US would end the QE policy, was flowing out of China under the guise of exports, a common way to bypass the country’s controls on cross-border money flows.

If the outflow persists, China’s money market will tighten, especially against a backdrop of slowing foreign investment.

Chinese policymakers will have to cope with the liquidity change by increasing money supply.

Short-term monetary tools including re-lending, standby lending facilities and pledged supplementary lending are expected to be used more often.

In the medium to long term, moves such as cuts in banks’ required reserve ratio and interest rates will also be considered.

This will test policymakers’ ability to strike a balance between liquidity and quality of economic growth.

China’s capital market is underdeveloped, with inefficient use of liquidity.

Money often goes to assets such as property and equities instead of serving real-economy sectors such as manufacturing and services.

What the Chinese policymakers are doing is keeping a lid on property and equity markets by tightening credit in an attempt to channel money to the real economy.

Now that the end of QE is expected to force Chinese authorities to loosen monetary policy, the core of the problem is to what extent the loosening should go.

For Chinese policymakers, it is essential to keep a cool head. They should not change their tightening stance.

China has a high savings rate and its social financing is abundant.

In other words, it is not short of money. The problem is how its rich money pool is used to help the real economy.

The sensible choice is that China stays away from all-round rate cuts to prevent a revival of property and equity bubbles but it can resort more often to short-term tools to shore up liquidity when necessary.

The end of QE will also bring some pressure to the internationalization of the Chinese currency, with the US dollar expected to appreciate and gain ground in the global market.

In the past five years, the rise of the yuan has been built on a weak dollar.

So a rising greenback is sure to prompt investors to change their portfolio by increasing their dollar assets. This means the globalizing pace of the yuan will slow a bit in terms of its popularity among foreign currency investors and traders.

The yuan’s popularity mostly comes from its rising value, not from ease of use or convenience.

China should take this time to rethink its currency strategy. It should slow a government-backed push to globalize the yuan and focus more on fundamental reform of the foreign exchange system to increase the yuan’s convertibility and convenience.

In this regard, forex investment controls and interest rate reform should be speeded up.

But the demise of QE is not all bad news.

One notable benefit is a fall in prices of commodities such as oil and iron ore. China has been struggling with high resources prices in the past decade.

The decline will help cut production costs, boost consumption power and increase the competitiveness of made-in-China products.

– Contact us at [email protected]


The writer is an economic commentator. He writes mostly on business issues in Greater China.

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