Measure would threaten China's forex security, increase inflation

BEIJING - The Federal Reserve said on Wednesday it could ease monetary policy further if the United States failed to see solid growth, which analysts said may add to China's inflation and endanger its $3.2 trillion foreign exchange reserves.

"The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support," Ben Bernanke, Fed chairman, told the House of Representatives Financial Services Committee. His remarks were generally interpreted as a signal of a possible QE3 (quantitative easing).

In late 2009, the Fed launched an unprecedented bond-buying drive to boost the economy and make credit more available, spending some $1.7 trillion on mortgage-backed securities and Treasuries before it ended in March 2010. It then initiated a second round of easing, that wrapped up in June, in which $600 billion of bonds were bought.

But the US economy remains weak, prompting the possible launch of a QE3. A Reuters/Ipsos poll released on Wednesday showed that the number of Americans who believe the country is on the wrong economic track rose to 63 percent this month, up from 60 percent in June. The country's jobless rate rose to 9.2 percent in June from 9.1 percent in May.

"If the Fed continues to print more money (as Bernanke hinted), it will drag China into a protracted war to limit liquidity and tame inflation," Lu Zhengwei, chief economist with Industrial Bank Co Ltd, said.

China's consumer inflation already surged to a three-year high of 6.4 percent in June, according to the National Bureau of Statistics. This was partly attributable to quantitative easing measures by the US, which drove global capital into the more lucrative developing markets, including China, analysts agreed.

Moreover, the potential injection of money in the US is likely to raise global commodity prices. Crude-oil futures finished higher on Wednesday boosted by Bernanke's comments. The rising prices may force emerging economies, such as China, Brazil and India, to pay more for imported commodities, further exacerbating their inflationary problems.

"It will be a very bad news for emerging countries," Lu said.

Those countries may have to continually tighten their monetary stance, such as by raising interest rates, further incurring capital inflows, Lu said.

Cao Fengqi, director of the Research Center for Finance and Securities at Peking University, told China Daily that a QE3 would lead to faster appreciation of the yuan against the dollar.

According to Cao, if the easing policy became a reality, the resulting flood of US dollars means a faster depreciation of the greenback, which threatens the security of China's foreign exchange stockpile as it will reduce the real value of the dollar-denominated reserves.

"The primary task for China is to control consumer prices and maintain steady and fast economic growth (to counter any external shocks)," Cao said.

The Foreign Ministry said on Thursday that it hoped the US government would take a responsible attitude to protect investor interests.

Bernanke's hint of a QE3 could also be a strategy to pressure lawmakers to agree on raising the US debt ceiling, analysts said.

US President Barack Obama and the Republicans are bogged down in negotiations to raise the borrowing limit before the Aug 2 deadline.

Bernanke may be "talking up the market" and goading Congress to reach a consensus on the ceiling, Chen Xingdong, chief economist with BNP Paribas Asia Ltd, said.

Moody's Investors Service on Wednesday put its AAA rating on US government bonds on watch for a possible downgrade, citing the "rising possibility that the statutory debt limit will not be raised on a timely basis", which would lead to a default on US Treasury debt obligations.

Meanwhile, Chinese rating agency Dagong Global Ratings Co Ltd on Thursday put US ratings on domestic and foreign currencies on a negative watch list because of the country's rising debt.

Dagong said the current political and economic situation had squeezed out room for tax increases, while it is difficult to curtail military and welfare spending.

In the worst-case scenario, the US public debt will continue to grow to 124 percent of the country's GDP in 2015, and the federal government will have to raise the debt limit by $5.5 trillion, Dagong said.

Dagong downgraded US ratings from AA to A+ on Nov 9, 2010 after the US government announced the second round of quantitative easing.

Wei Tian contributed to this story.