The US Federal Reserve's policy of printing money to buy Treasury debt threatens to set off a serious decline of the dollar and compel China to redesign its foreign reserve policy, according to a top member of the Communist hierarchy. Cheng Siwei, former vice-chairman of the Standing Committee and now head of China's green energy drive, said Beijing was dismayed by the Fed's recourse to "credit easing". "We hope there will be a change in monetary policy as soon as they have positive growth again," he said at the Ambrosetti Workshop, a policy gathering on Lake Como. "If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies," he said. – Telegraph

Dominant Social Theme: The Chinese hope for common sense.

Free-Market Analysis: The Chinese are tightening the screws in our estimation, making it clear to the United States that continued funding of the American national debt by over-printing money is simply unacceptable. But we don't necessarily see that the Chinese are operating from a position of strength. We've written several times in the past that the Chinese economy is one big bubble – easily the biggest in the world – and later in this article, excerpted above, Cheng Siwei confirms part of our analysis, as follows:

Mr. Cheng said the Fed's loose monetary policy was stoking an unstable asset boom in China. "If we raise interest rates, we will be flooded with hot money. We have to wait for them. If they raise, we raise.

"Credit in China is too loose. We have a bubble in the housing market and in stocks so we have to be very careful, because this could fall down."

Mr. Cheng said China had learned from the West that it is a mistake for central banks to target retail price inflation and take their eye off assets.

"This is where Greenspan went wrong from 2000 to 2004," he said. "He thought everything was alright because inflation was low, but assets absorbed the liquidity."

Mr. Cheng said China had lost 20 million jobs as a result of the crisis and advised the West not to over-estimate the role that his country can play in global recovery.

China's task is to switch from export dependency to internal consumption, but that requires a "change in the ideology of the Chinese people" to discourage excess saving. "This is very difficult".

Mr. Cheng said the root cause of global imbalances is spending patterns in US (and UK) and China.

"The US spends tomorrow's money today," he said. "We Chinese spend today's money tomorrow. That's why we have this financial crisis."

Yet the consequences are not symmetric.

"He who goes borrowing, goes sorrowing," said Mr. Cheng.

Hey … the clever, fortunate few who read the Daily Bell regularly will see in Cheng's remarks above virtual confirmation of the Bell's analysis of China. Our position has been consistent throughout. China cannot export her way to continued economic health but must look for growth internally. The old men of the Chinese leadership council are deathly afraid of the 400 million or so impoverished rural Chinese who have not yet felt the benefits of the Chinese economic miracle. There seems to be some sort of time limit here. Either this group is pacified or China gradually ignites and the social order – which does not seem very strong to begin with – weakens further and perhaps breaks down.

But it is not easy, all of this … The reason that Cheng says switching growth around from export to import is difficult is actually two fold. One, the Chinese have a culture of saving, not spending and the population has looked askance at the West's endless consumption of foolish or unnecessary products. Now the Chinese government will ask its citizens to mimic Western foolishness for the greater good.

Second, the Chinese government itself must be increasingly worried that as the Chinese living standard rises, the people will want more than material possessions. When a poor people begin to rise, little may asked or required from the government but more of the same. Materialism is attractive and comforting. But after a certain point, inevitably a percentage of citizens are not satisfied with materialism but seek the political power that comes with successful entrepreneurship. As China reaches this point, and she will eventually, the political situation shall likely become even more fragile and prone to breakdown.

The Chinese leadership is in a double bind. If they do not lift 400 million rural citizens out of poverty quickly, the sociopolitical pact, already frayed by corruption and other difficulties, may break down entirely. If the Chinese leadership does manage to stimulate internal consumption, the result will be, inevitably, a rising dissatisfaction with a culture that allows wealth to be gained but not political power.

Not only that, but as the Chinese leadership struggles to navigate these twin shoals of political disaster, there is the knowledge that after a decade of 10 percent per year growth, the Chinese economy probably comprises the largest un-punctured bubble in the world. Cheng acknowledges some of it, but he is being cautious about the reality of the situation. If the stock and housing markets are in a bubble – and actually the bubble is already in some stage of collapse according to reports from those who have visited China and seen the vacancies in its big cities – then the larger financial industry and China's banking system itself are probably far more compromised than the Chinese have let on.

We do not doubt this is so. The Chinese manufacturing sector has already collapsed to some degree. But the real mess is in the financial sector, such as it is. We have long held that the Chinese have adopted some of the outward show of Western-style banking disciplines – accounting, reserve formulas, etc. – but in reality the Chinese central bank prints as many yuan as it wishes too and the commercial banks pump out the paper money as fast as possible. It's a rudimentary system, no more complex than its ruinous Western counterpart.

This is why when Cheng speaks as if the Chinese have some lock on fiscal prudence, the sentiment is fairly risible. The old, frightened Chinese leaders have kept the pedal to the floor and pumped the system up as far as it will go. As usual the Western mainstream press has entirely missed this story. Because the Chinese started off with a billion people desperate for work and an unparalleled industrial capacity as a result, the Chinese are now to be seen as some sort of paragons of fiscal prudence. Nonsense. When the Chinese economy finally fully implodes, please, dear reader, remember WE TOLD YOU SO.

There is no appreciable difference between the Western system of finance and the Chinese system at this point – except that the Chinese are likely far more irresponsible than Western bankers who have been kept vaguely in check by cultural parameters. The conservative gold-standard banking of the 1800s has long since vanished, not that the Chinese participated much in that system anyway. Today, Western banks remain in a bubble and Chinese banks – and the larger Chinese economy – after more than a decade of 10 percent growth (if we believe Chinese figures) is likely in a hyper-bubble. Time will tell of course. It always does.

It is easy to write an article about China today for a mainstream newspaper. One only has to write in glowing terms about the Chinese miracle, Chinese prudence, the excellence of Chinese financial governance, and then wax disapprovingly when it comes to Western profligacy. In truth the West IS profligate. But it is nothing compared to the Chinese. The entire Chinese miracle in our opinion has not been based on sound economic policy but on poverty and previous lack of opportunity.

Twenty years ago the Chinese people had nowhere to go but up. But now, with a modern infrastructure and an educated people, the Chinese need to figure out how to sustain their miracle, and that will inevitably take freer markets and a less rigid and polemical political environment. The last time we looked, the answer to additional freedoms in China were the tanks rolling into Tiananmen Square. So, good luck with that.