China's Dagong Sees No Threat Of Fed Monetization Ending, Believes "World Credit War" Is About To Escalate

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Starting to get doubts about QE3? Don't tell that to the official Chinese rating agency Dagong, who in traditional uber-pragmatic fashion, has the following summary observation on US monetary policy, and any imaginary changes thereto: "The second round quantitative easing policy ongoing in the United States can not change its weak domestic demand in the short term. In fact, it can only lower the interest rate of US Treasuries so as to maintain stable interest rate in the capital market in the long term, playing the indirect role of clearing some obstacles for a stable recovery. However, the plan of purchasing 600 billion US dollar Treasury bonds can not realize its predicted goal; and therefore, the United States will hardly change its predetermined monetary policy in 2011." What does this mean for China and the rest of the world: "The continuous implementation of such unconventional monetary policy in the United States will lead to the escalation of world credit war and inflict greater losses for related parties in the world credit system." Any questions?

Full selection from Dagong's report on the question of US monetary policy:

The United States, as the biggest country involved in sovereign debt crisis around the world, will continue its  quantitative easing policy when the country is in danger, and the world credit war will be escalated due to the overflow of US dollars

The second round quantitative easing policy ongoing in the United States can not change its weak domestic demand in the short term. In fact, it can only lower the interest rate of US Treasuries so as to maintain stable interest rate in the capital market in the long term, playing the indirect role of clearing some obstacles for a stable recovery. However, the plan of purchasing 600 billion US dollar Treasury bonds can not realize its predicted goal; and therefore, the United States will hardly change its predetermined monetary policy in 2011. The continuous implementation of such unconventional monetary policy in the United States will lead to the escalation of world credit war and inflict greater losses for related parties in the world credit system.

First, the trend of long-term depreciation of US dollar will result in haircut of international creditors’ debts dominated in US dollar. As the interest rate of US government debt is lowered due to the quantitative easing policy adopted by  the United States, creditors can not obtain the investment return commensurate with the risk status of US Treasuries. At the same time, the depreciation will also cause continuous exchange losses for the international creditors. Since June 2010, the US dollar has significantly depreciated compared with the currencies in emerging market countries and some developed countries, and the depreciation is 3.0% against RMB, 12% against Brazilian Real, 14% against South African Rand, 19.5% against Australian dollar and 11.4% against Korean won. The trend will continue in 2011, and international creditors will lose all their profits of the US dollars in exchange for the export income under the gradual depreciation of the currency. The behavior that the United States ignores international creditors’ legitimate interests indicates a dramatic decline of the country’s willingness to repay the debt.

Second, rapid inflow of capital will cause risks regarding inflation and asset bubbles in the emerging market countries, which is unfavorable for those countries to maintain their debt repayment credit. As a result, emerging market countries, including some developed countries and regions with good economic recovery, will have to withstand the economic and financial impact arisen from the inflow of capital in 2011. If the capital inflow exceeded the capacity that the domestic economic and financial development can absorb, some of the capital will flow over in the real estate market, capital market such as stocks and bonds and some commodity market to raise the asset price in the domestic market and eventually accelerate the inflation. Most of the countries have transferred to neutral monetary policies and will speed up the contraction of their monetary policies; however, due to the viscosity of the currency and imbalance of capital inflow in different industry, and yet the policies and measures will exert general restrictive effect on capital in the overall domestic market, the healthy development of the domestic economy will inevitably be damaged. Some Asian countries, for the purpose of eliminating the damage to the export in case of rapid currency appreciation, take some intervention measures, which bring increase of foreign reserves at a faster speed, and the consequent hedge cost is not favorable for the inflation control. While the capital retrieves quickly, the fall of asset prices will impose adverse impact on the robustness of the banks, domestic consumption and stability of the exchange rate.

Third, the issuance of US dollar encourages numerous speculative capitals into the global commodity market, leading to an increasing pressure on global inflation. The quantitative easing policy conducted by the Fed in a continuous way failed to promote the expansion of domestic credit scale; rather, the liquidity accumulated inside the financial system, in addition to flowing to foreign markets, has been used for financial speculative investment, causing surge of prices of global commodities including energy, raw materials, and foods; and almost all countries, as a result, have suffered losses arisen from the imported inflation to different extent. In EU and the eurozone countries where see the slowest recovery, the annual inflation rate has increased to 2.6% and 2.2% respectively by December 2010, the figure for countries with serious inflation, such as Romania, Greece and Hungary, has reached 7.9%, 5.2% and 4.6%  espectively.

The anti-inflation measures make the weak economic recovery even worse. In general, the capital inflow and inflation pressure that emerging market countries are experiencing will, on one side, directly affect the governments’ capacity for repaying local currency debt from the perspective of its influence on the value of local currency, and on the other side, indirectly and more seriously threaten the governments’ credit based on its adverse influence on healthy development of macro economy and financial security.

Currency system is the carrier of credit system, and therefore, the value of the currency determines the quality of credit system. International currency is the carrier of international credit system, and the instability of the currency value and the depreciation trend arisen from the over issuance make the function of the US dollar as the value scale distorted, which make other countries in the world pay an undeserved cost for their subsistence and development. The strike of shortterm capital dominated in US dollar to the emerging economics has made the excess US dollar capital become the destructive factor to the healthy economic development in different countries. The international credit system established on the basis of US dollar as the intermediary has been twisted in a way that the impartiality and reasonable aspect of the current international credit relations gradually vanish. Different countries, in order to avoid unpredictable losses on their own interests, will have to seek for adjustment of international credit relations, and the global credit war, no doubt, will become the turning point of reforming international credit relations in 2011.

Full report link

h/t Cate Long