The Fed Attempts to Smash Chinese Dollar Peg with QE 2

The United States Federal Reserve last week announced it would inject an extra $600 billion into its banking system under the assumption that the massive printing of money will stimulate GDP, jobs, or they hope at least a little inflation. (Good luck on keeping inflation contained.)

Everyone here in China is talking about the Fed money printing. As a manager of a steel plant in China, I got a 5% increase in Scrap Steel Prices and Pig Iron 2 days after the announcement of QE2. All of the commodity suppliers in China have changed price forecasts from "stable" to "price increases."

When we take into account the simple fundamental laws of supply and demand, all of us holding dollars just lost money. The greater the supply of any commodity, the lower the value. The largest losers were the world’s central banks. China’s central bank alone holds more than $2.65 trillion in dollar reserves.

This QE or quantitative easing has caused immediate criticism from the world including Brazil, Germany, and China. The overseas edition of the People’s Daily said in a front page commentary that this quantitative easing was bad for China and bad for the world. Shi Jianxun of Shanghai’s Tongji University wrote that Washington's latest move to print more money is a form of indirect currency manipulation that could lead to a new round of currency wars and even global economic collapse. (I guess direct currency manipulation by China doesn’t matter?)

This new money printing comes at a time when the world is already ablaze with inflation. Indian inflation is over 10%, Chinese inflation is also widely under-reported and way above 7-8% or more. Asian countries including Australia are all increasing interest rates to try and control inflation and hot money flows into their economies. Cotton prices are up 78%, everything is going up. Gold is the tell-tale, up over 25% for the year.

With all of these factors considered, why has the Fed taken such a huge risk at more dollar printing? Is this $600 Billion QE printing of money aimed directly at the Chinese Dollar Peg?

The RMB is fixed to the dollar and China is causing massive imbalances through direct currency manipulation. The U.S. is sending waves of money into the global financial system through indirect currency manipulation. It seems obvious that the United States is telling China, you can keep the peg but well just print more money.

The Chinese-Dollar peg is no doubt a major contributor to the global imbalances currently present. In the past this made sense as the Chinese economy was much smaller and it provide a stable environment for the plants to build their export business, however, today you have the world’s two largest economies with currencies pegged to each other. One economy has no growth, a 23% U6 unemployment rate and 42 million people on food stamps. The other economy is growing too fast with over 10% growth rates and is creating asset bubbles in their domestic real estate, and global commodity prices. The two large economies are locked together in a death struggle and there is no mechanism to relive the pressure of the trade imbalances.

At this stage,with the current financial position of the United States, the only long term solution to the U.S. economy outside of default is to print money to pay the debts and lower the value of the dollar to bring jobs back to the United States. QE 2 could accomplish both of these objectives; however, as the Fed prints to weaken the dollar, the world’s other economies see their currencies drop 20% or more against the Chinese RMB.

Japan, India, South Korea, Germany, and other nations are not afraid of competing against a lower dollar…… they are afraid of competing against a lower RMB. Until the Chinese dollar peg is dropped, countries will do everything they can to continue to keep their currencies artificially low against the USD. This will send global commodity prices higher and higher.

At this stage, it appears the Chinese dollar peg is here to stay which is not good news. The new Republican Tea Party members recently elected are not fans of free trade and we will no doubt see a trade war ensue. In fact this week, Senator Lindsey Graham warned of a “period of confrontation” with China over its currency.

We can expect to see a continuation of increasing trade friction going forward as well as more money printing out of the Federal Reserve. Got Gold?