US balance sheet reduction won't make waves for now
- By Xu Feibiao
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E-mail China.org.cn, October 1, 2017
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A clerk counts money at a bank in Taiyuan, North China's Shanxi province. [Photo/China News Service] |
The balance sheet reduction announced by the U.S. Federal Reserve on September 20 has drawn world-wide attention. The force of impact of the Fed's policy will inevitably "spillover" to produce lasting and far-reaching influence on all countries, including China.
The Fed's decision was expected and, so far, there have been no big waves. For China, an accurate and comprehensive assessment is still needed to make the best use of the situation and turn possible adverse conditions into favorable ones.
The Fed turns danger into safety
The Fed's balance sheet had ballooned to around US$4.5 trillion following three rounds of quantitative easing to withstand the impact of the 2008 global financial crisis. When and how to safely pull back from the "financial cliff edge" is something the Fed has been trying to solve for some time.
Its decision was made after repeated studies and arguments. It is characterized by a gradual withdrawal of the monetary base from the market, a passive withdrawal of capital from circulation, and flexibility in monetary policy.
More specifically, starting from October, the Fed will reduce its balance sheet by US$10 billion of assets every month, and then gradually adjust the amount until the "ideal scale" is reached, whatever that might be. At the same time, it will keep its interest rates (1-1.25 percent) unchanged to ease the impact of the balance sheet reduction on the market.
A ripe time for the Fed's decision
This decision was made out of the following three considerations.
First, the global economy continues to improve. The world economic recovery has stabilized since last year. A recent report from the Organization for Economic Cooperation and Development (OECD) predicted overall growth of 3.5 percent this year, and 3.7 percent next year, the best performance since 2011.
Second, maintaining stability of the financial market has become an important policy focus. Currently, the Dow Jones index has surpassed 22,000 points. If the stock market goes into reverse again, American economic downside risk will increase significantly and possibly trigger a new wave of financial crises. Moderately reducing the excess reserves of banks and other financial institutions is conducive to maintaining financial stability.
Third, the decision hopefully will set the tone for the future policies of the United States. The new administration in Washington has frequently intervened in the Fed's decisions through "outrageous" words and deeds.
Meanwhile, with a future increase in the number of senior financial officials to be appointed by President Donald Trump since the term of a number of Fed officials including Janet L. Yellen will end soon, the impact on the Fed is growing considerably. Thus, its monetary decision this time will help ensure long-term policy independence and reduce political risks.
A long-term impact cannot be ignored
Given China's sound economic fundamentals, there is no need to worry about the short-term impact, but a medium- and long-term impact should not be ignored. There are three major reasons.
First, international liquidity is further tightened. The U.S. economy has returned to pre-crisis levels and market vitality has been restored, laying a foundation for the withdrawal of broad currency, while the recent weakness of the U.S. dollar provides a good moment for action. It is foreseeable that in coming several years, China will face a greater pressure of capital outflow.
Second, international financial risks have risen. Global economic growth has improved since last year and the international stock of liquidity is abundant, but at the same time, the debt levels of newly developing and developed countries are high, with increased leverage. In this context, the Fed's balance sheet reduction may probably "pierce" some bubbles in the global financial market and lead to new crises. Historically, all previous global financial crises have been marked by the Fed's balance sheet reductions.
Third, China's "Belt and Road Initiative" and other related international trade cooperation projects could be disturbed. A large amount of funding is needed from both home and abroad for implementation of the policy.
The Fed's QE withdrawal will accelerate international capital inflows into the United States, and China may face competition from the United States in seeking funding. At the same time, it also increases the difficulty and cost to some extent for the RMB to go global.
In view of these reasons, domestically, China should deepen the economic structural reform and the market-oriented financial reform, strengthen control of capital flows and prevent international financial risks. Internationally, it should increase bilateral and multilateral financial cooperation, strengthen the building of international financial safety networks and jointly promote international financial governance.
The author is a researcher with the China Institute of Contemporary International Relations.
The article was translated by Li Jingrong from an unabridged version published in Chinese.
Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.
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