This all sounds technical but, heck, it has real implications especially for us in Britain. When this crisis started and Quantitative Easing became the panacea I was struck by the number of people in financial - NOT banking - circles who warned that QE would end up with hard to control inflation and all QE would do was postpone the day of reckoning (till after the election!!) and make shedding our debt burden infinitely harder.
We got into this mess by Gordon Brown imprudently borrowing in the good times when we should have repaid our debts. We are now faced with repaying those much bigger debts in the bad times. Britain under Brown is like someone that cannot meet its credit card repayments so takes out a new and more expensive card and borrows more on that too.
The banks love QE and urge Brown to continue! Well, they would, wouldn’t they? All that money is deposited to their credit with the BoE, resulting in greatly improved balance sheets at our expense
As I said at its beginning, QE was the start of a slippery slope . It makes matters worse every day it continues. Stopping it will be painful immediately, but going on would make the end crisis far worse than it need have been.
Christina
SUNDAY TELEGRAPH
13.9.09
Cheap dollars are sowing the seeds of the next world crisis
After years of selling cheap goods to debt-fuelled Western consumers, China now has $2 trillion dollars of foreign exchange reserves. That's 2,000 billion – a reserve haul no less 25 times bigger than that of the UK.
By Liam Halligan
In a world of systemic instability, reserves mean power. Reserves mean you can defend your currency, stabilise your banking system and boost your economy without resorting to yet more borrowing – or, worse still, the printing press.
More than half of China's reserves are denominated in dollars. So when the dollar falls, China loses serious money. When you're talking about a dollar-reserve number involving 12 zeros, even a modest weakening of the greenback sees China's wealth takes a mighty hit.
In recent years, America has run massive budget and trade deficits, both of which put downward pressure on the dollar – so devaluing China's reserves. Beijing has remained tight-lipped, worried less about diplomatic niceties than the financial implications of voicing its concerns. If the markets thought China would buy less dollar-denominated debt going forward, the US currency would weaken further, compounding Beijing's wealth-loss.
American leaders have relied on this Catch-22 for some time, guffawing that China is in so deep it has no choice but to carry on "sucking-up" US debt. But Beijing's Communist hierarchy is now so worried about America's wildly expansionary monetary policy that it is speaking out, despite the damage that does to the value of China's reserves.
Last weekend, Cheng Siwei, a leading Chinese policy maker, said that his country's leaders were "dismayed" by America's recourse to quantitative easing. "If they keep printing money to buy bonds, it will lead to inflation," [Which is exactly the same and just as true for what we’ve been doing - infl`ation will follow -cs] he said. "So we'll diversify incremental reserves into euros, yen and other currencies".
This is hugely significant. China is now more worried about America inflating away its debts than about those debts being exposed to currency risk. Economists at Western banks making money from QE still say deflation is more likely than inflation. As this column has long argued, they are talking self-serving tosh. [My contacts in the City say the same thing and I have reported their warnings of inflation. Our QE is stoking up worst trouble yet to come -cs]
The entire non-Western world rightly sees serious inflationary pressures down the track in the US, UK and other nations where political cowardice has resulted in irresponsible money printing.
Following Mr Cheng's comments, the dollar fell throughout last week, hitting a 12-month low against the euro. As the dollar's "safe haven" status was questioned, gold surged above $1,000 an ounce to an 18-month high.
The US currency could well keep falling. America's trade deficit grew in July at the fastest rate in almost a decade. Imports exceeded exports by $32bn last month – a gap 16pc wider than the month before. One reason was that as oil prices strengthened, so did the cost of US crude imports.
Oil touched $72 a barrel last week. If the greenback weakens further, prices will keep going up. That's because crude is priced in dollars and global investors will increasingly use commodities as an anti-inflation hedge.
These forces could combine to send the dollar into freefall. US inflation would then soar and interest rates would have to be jacked up. Even if a fast-collapsing dollar is avoided, Fed rates may have to rise quickly if China is serious about dollar-divesting and the US has to sell its debt elsewhere. Under both scenarios, the world's largest economy could get caught in the stagflation trap – recession and high inflation.
Beijing doesn't want the US to stagnate. China has too much to lose.
But even if China and US work together to avoid a meltdown, the currency markets could provide one anyway.
The dollar is now being used as a "carry" currency. Traders are using low Fed rates to take out cheap dollar loans, then converting the money into currencies generating higher yields.
"Carrying" credit in this way is currently the source of huge gains. No one knows the true scale, but the world has, of course, been flooded with cheap dollars.
This presents serious systemic danger. A dollar weighed down by Chinese divestment, then suppressed further by carry-trading, could easily spring back. Those who had borrowed in dollars would owe more, while their dollar-funded investments would be worth less. This "unwinding" could send financial shock around the globe.
This is what happened in 1998, when yen carry-trades went wrong, causing the collapse of Long-Term Capital Management and sparking a global slowdown.
So even if the Western world manages to fix its banking system, the Fed's money printing could well be stoking up the next financial crisis. The dollar carry-trade. You heard it here first.
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•Liam Halligan is chief economist at Prosperity Capital Management
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