You may have recently read about the Chinese discomfort with the recent expansion of the US Fed’s balance sheet. The worry is based on the claim that a bigger balance sheet means more green-backs are out and about in the world, implying inflation. This would be quite a bad thing for the Chinese – their reserve balances recently eclipsed $2 trillion, with the majority in $US denominated treasury bills. Significant inflation would erode these assets.
This idea has been looked at by several different authors recently, who generally go over exit strategies the Fed could take to avoid any problems (in my opinion Jim Hamilton is the one you want to read – link ). Another approach to this issue, however, was just offered up by Brad Setser, and I think it’s great: Pot calling kettle black
One thing that has puzzled me is that some of the countries that have — implicitly at least — been most critical of the expansion of the Fed’s balance sheet during the crisis long have had much larger balance sheets than the US Federal Reserve.
Before the crisis, the Fed’s balance sheet was around 6% of US GDP. Right now, it is around 15% of US GDP. A big increase no doubt. But the balance sheet of the People’s Bank of China (PBoC) is around 70% of China’s GDP. Foreign assets make up about 80% of the PBoC’s balance sheet — or around 55% of China’s GDP. And the PBoC’s estimated holdings of US treasuries and agencies are about equal to 30% of China’s GDP — a level that is far higher, relative to China’s GDP, than the US Fed is ever likely to achieve. The Fed expects its balance sheet to peak at roughly $2.5 trillion, or between 15% and 20% of US GDP.
Oh snap! Check the link for further comment on how to sterilize the expansion to prevent inflation.