QE2 and the Art of Economic War

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Quantitative easing is unpopular with bears for its artificial market support and distortion of trading patterns. It is great sport to poke fun at the Secretary of the Treasury and the Chairman of the Federal Reserve for their seemingly idiotic, irresponsible money printing, bond-buying polices. But Turbo-Tax Timmy and Helicopter Ben are not dummies. It is worth considering whether the current QE policies are aimed at state interests far beyond the stated goals of: To provide further support for the economic recovery while maintaining price stability.

The U.S. is currently involved in several wars, but the conflict with the biggest stakes is only starting to be recognized. This is the economic war between the United States and the Peoples’ Republic of China. The U.S., as the world’s superpower, has much to lose to an ascendant China. Chinese economic strength supports its political, ideological and military power. Unlike the U.S. eclipse of the British Empire in the 20th Century, China’s new hegemony will not be a win-win handoff of the superpower baton. What is good for China is not likely to be good for the U.S.  This conflict is a new Cold War, with potential for escalation into military operations. The fight between China and the U.S. will define the structure of world power for the remainder of the 21st Century.

China is employing radical mercantilist policies at an extreme, state-orchestrated level. China provides state support for all facets of its export economy, with no concerns for fairness, balance of trade, intellectual property or other sentimental western constructs.  China’s beggar-thy-neighbor economic policies are eroding the workforce, capital, manufacturing base and research and development capabilities of competitor nations. It is worth noting that similar collateral damage from the world wars of the 20th century helped to establish U.S. as the superpower of today.

If you were fighting this economic war as the President of the United States, what would you do?  What would most inhibit China’s rise as an industrial, economic and military power? As war has been a Chinese pastime for millennia, cribbing ideas from the enemy might be a good place to start:

So in war, the way is to avoid what is strong   and to strike at what is weak.
Sun Tzu, On The Art of War

OK, POTUS, let’s consider Chinese weakness. China has a large peasant population with middle-class aspirations. Internal political turmoil, potentially even revolution, will result if the people of the PRC do not share in the country’s economic success. To meet these expectations, China must maintain high economic growth rates, driving its industrial revolution at a blistering pace, putting upward pressure on prices of raw materials, food and energy. To keep its exports affordable to American Wal-Martians, China pegs its currency to the $USD and has been only very reluctantly raising interest rates. China has purchased great quantities of U.S. Treasury bonds, to support its debtor consumer market.

To exploit these weaknesses and attack China, it would be hard to develop a more potent weapon than Quantitative Easing. U.S. money printing increases inflationary pressures, making commodities needed to fuel China’s growth more expensive, particularly as long as China keeps its peg to the weakening dollar. With inflation in necessities such as food and housing, the Chinese people will begin to experiencing a declining standard of living, sowing the seeds of social unrest. QE bond purchases dilute the value of Chinese UST holdings and with that, the Chinese leverage on U.S. financial policy.  As China tightens its economic policy to fight inflation, their currency strengthens, their exports become less competitive and their economy and world influence, declines. So maybe there is a bit more to QE2 than first meets the eye.

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