China: QE2 exposes global monetary flaws

BEIJING (Reuters) - The U.S. Federal Reserve's launch of more quantitative easing is understandable, but the decision may pose problems for the global economy and illustrates why the international monetary system must be reformed, China's central bank governor said on Friday.

Zhou Xiaochuan, head of the People's Bank of China, made waves last year in suggesting that the Special Drawing Right, the IMF's unit of account, should eventually displace the dollar as a global reserve currency.

He revisited the central element of his argument in a speech on Friday, saying that there was an intrinsic conflict in the way the United States manages its economy.

"We can understand the Fed's QE2 policy, from the angle that it wants to revive the U.S. economy and increase employment. But the problem is the dollar is the global reserve currency," he told a forum.

"It may not be the right choice for the global economy, though it is a good option for the U.S. economy," he said.

Rather than just criticizing the Fed, Zhou said that thought should be given to more fundamental reform.

"If we oppose this policy, we probably need to rethink problems in the international monetary system, how to improve the system when the U.S. domestic role and global role conflict with each other."

In an essay last year, Zhou said that reserve currency-issuing countries would get tripped up by the so-called Triffin Dilemma -- the idea that they cannot issue enough money to satisfy the global appetite for reserves without eventually depreciating their own currency.

In the near term, economists have warned that large-scale monetary easing in the United States could push a wave of liquidity into global markets that will threaten fast-growing developing economies with speculative inflows and asset bubbles.

WARDING OFF INFLOWS

The World Bank said this week that China was in a better position than most to resist such inflows, and Zhou concurred.

"As for whether hot money will come into China, I think that our existing foreign exchange controls are able to ward off irregular capital inflows," he said.

Turning to China's own economic policies, which themselves have been the subject of fierce global criticism, Zhou defended the county's approach to reform.

China wants to reduce its whopping trade surplus, but will not rely on its exchange rate policy alone to do so, he said.

"We have different medicines. Exchange rate policy is only one of them. China does not want to emphasize only one single medicine," he said.

Zhou said that China had decided to largely give up one kind of medicine: tax breaks for exporters.

"We are not using as many export tax rebates as before, because we saw that their side-effect was to trigger trade frictions," he said.

China has pledged to reform its exchange rate to make it more flexible, but other countries, especially the United States, say that it deliberately keeps its currency undervalued to give its exporters an unfair advantage.

Beijing has let the yuan rise about 2.5 percent since depegging it from the dollar in June.

(Reporting by Aileen Wang and Simon Rabinovitch; Editing by Ken Wills)