The devaluation of dollar assets has caused direct losses for Chinese financial institutions, Yu said. The massive foreign reserves the country has accumulated over the last couple of decades are quickly depreciating. The U.S. Federal Reserve's policy changes magnify the difficulties of China's macro-control policies.

But worse still is that the U.S. recession is pulling down China's economic growth, Yu said. The American recession also would exert negative influence on economic growth in other countries, further decreasing their demand for Chinese products, he said. The shrinking exports would directly pull down GDP growth, investment and imports needed for the processing trade sector, the backbone of the country's overall exports and imports.

Yu said his institute is now estimating the U.S. economic recession's impact on China's economy. The preliminary conclusion is that China's GDP growth rate would drop 0.94 percentage points if the U.S. economic growth rate slowed down 0.7 percentage points as the International Monetary Fund has anticipated.

Yu also said the renminbi's appreciation against other major currencies would have negative effects on China's economic growth. He estimates that if the renminbi appreciates 10 percent this year, the growth rate of China's net exports would drop to 25 percent. Under such a scenario, the GDP growth could drop 2 percentage points.

"Coupled with the decrease of net exports and consumption, Chinese economic growth will be seriously exacerbated," Yu said.

Policy dilemma

On May 20, the central bank raised the reserve requirement ratio for the fourth time this year to 16.5 percent.

In 2007, the government decided to maintain a stringent monetary policy to cope with inflation and the overheated economy. But the money liquidity in the market did not seem to be influenced by the frequent controlling measures. Data from the central bank's May 13 report indicate that market liquidity was still sufficient. The balance of loans of financial institutions stood at 29.86 trillion yuan ($4.27 trillion) by the end of April, up 16.13 percent year on year.

The snowstorm in the southern part of the country earlier this year and the devastating earthquake in May made the country hungry for more cash. Domestic economic experts are having broad discussions about whether the central bank should continue its stringent monetary policy.

Another monetary policy problem stems from the renminbi's appreciation. The currency's fast appreciation since the beginning of the year has had clearly negative impacts on Chinese exports, putting many domestic factories in dire straits. Many exporters are against the renminbi's continued appreciation, while some even have suggested that the government resume the pegging mechanism.

Yu has other concerns. He said the devaluation of the U.S. dollar and worsening inflation in the United States have turned the yields on U.S. treasury bonds negative. China is losing much in the international economic marketplace, he said.

While China is raising interest rates, the United States is cutting them. Expectations for the renminbi's further appreciation has attracted more international speculative money, adding more pressure to the country's monetary policy, Yu said.

Financial decision makers in China are brainstorming on what the country should do next. To improve the situation, the government must quicken its pace in reforming foreign exchange mechanisms by increasing the flexibility of foreign exchange as a tool for combating financial problems, Liu said. It also should maintain a stringent monetary policy to curb demand for cash and inflation, expand government expenditures and indirectly promote individual consumption, he said. Liu believes this is the best way to ensure a soft-landing for the Chinese economy.