QE2 and U.S. China Politics, Shrewd as Serpents

By: Submissions

Everyone has heard about the Prisoners' Dilemma before, I suppose. For those who don't know, here is the gist: It is about a situation between two players that if they cooperate, they will get the biggest benefit. However, if one decides to cooperate yet get betrayed later, he will suffer more than if he simply betrayed the other guy in the first place. Logically, the two players should simply cooperate, but sometimes when you are uncertain about the other player's sincerity, the situation becomes tricky.

This is certainly a good analogy between China and the US. If they can work together, both sides are likely to win and bring the world out of the financial mess. Unfortunately, this is unlikely to be true, because right from the start both sides had adopted a mindset recovering at the expense of the other.

You have to admire the shrewdness of the US in international politics. After the meltdown of Lehmann in 2008, they were in a liquidity squeeze and an urgent need for liquidity, but they did not want to print all the necessary cashflow by themselves, for otherwise it would damage their financial credibility too much. Therefore, they thought of a way to get others to print money for them: they pretended to be going bankrupt soon, and urged the world to do something to save them.

And they successfully enticed China, who held the most US debts and feared all the debts would turned bad. It reminded us the saying, "if you owe $1000, you worry; but if you owe $100b, the bank worry." Convinced for a potnetial default, China launched a huge rescue plan and bumped 10T of Yuan (about USD 1.4T at that time) into their economy. Only then, the US slowly carried out their stimulus package much later, and it was only worth USD 0.8T.

At that time the US were blamed for acting slow and China was the hero, but the savior one year ago is now the source of all asset bubbles and inflations, as well as the "evil" currency manipulator. On the other hand, the US economy is still the most resilient in the world, and no one seems to be accusing the Fed and other US financial firms for doing similar things for the dollar.

And here is the latest episode of the US-China drama: QE2. It's effectiveness as an economic stimulus has been questioned by many, as economist Joseph Stiglitz has argued that what the US need are real policies that stimulate the economy. He pointed out that printing money will not only re-created the housing bubbles and bank regulation problems in the US, but also hurt the Sino-American relation.

The problem is, the US are not very keen in making friends with China. Their main concern is how to keep the inflation going in the emerging markets, so that the competitive advantages of the emerging markets will get neutralized to a very large extent. Bernanke made it obvious that combating deflation is now his first priority. Employment? Perhaps we will come to that sooner or later.

Of course the emerging markets are not dumb either. For example, other than China, Korea had also taken actions to blockade foreign cashflows. However, this alone is not enough to counter against the US, because the US dollar has another dreadful weapon - rising material price.

There were several attempts in history to change the pricing of oil into other currencies, and they all failed inevitably, because that the are challenging America's direct control of the oil price, and the US had defended this pricing tradition at all cost. The printing of the dollar has another effect: it pushes the price of the commodities so high that, along with inflation, it increases to cost of productions in emerging markets. This is a much more difficult threat for the emerging markets to fend off.

In the international world, it is my impression that almost over a half of the present problems can be resolved if the US and China come to a deal. I believe any trader or investor would benefit a lot if they pay close attention to the duels between these two giants in the world.

http://wisdomisprofit.blogspot.com

Victor Chan Wai-To is a currency trader based in Hong Kong.

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