September 21, 2015

"As Chinese President Xi Jinping begins his long awaited visit to the U.S., there will be plenty for him to discuss with President Obama–trade issues, cyber-security, conflict in the South China Seas, and so on."

Time One topic that has gotten less attention, but should be top of mind: monetary policy. That’s because what’s happening in China right now has limited the ability of the Federal Reserve Bank to do what’s right for the American economy. by Rana Foroohar

'In important ways, China now controls U.S. monetary policy. What happens in the Middle Kingdom affects the decisions that Fed chair Janet Yellen can make about whether to raise or lower interest rates. We saw this just a few days ago when the Fed held fire on a long awaited hike in rates (despite the fact that the U.S. is at full employment) because of global economic headwinds emanating from China, most particularly the disinflationary effect that slower Chinese growth has on the world. Yellen needs inflation to be higher–and in particular, she’d like to see wage inflation be higher–before raising rates. Yet there’s no indication that will happen anytime soon, and China is a big reason why.

'As I wrote a couple of weeks back, the economic slowdown in China and the crash of the Chinese equity market (which is a symptom of the former, not a cause) is really the echo of 2008. When American consumers stopped buying stuff after the subprime crisis, China tried to take up the slack in the form of a massive government stimulus program. This meant a major run up in debt. A few years back, it took a dollar of debt to create every dollar of growth in China. Now it takes four times that. The debt-to-GDP ratio in China is a nauseating 300%. (American debt hawks worry about our rate, which is less than a third of that.)

'A couple of years ago, that bubble started to burst. The Chinese government tried to stop it, by propping up one market after another, from housing to stocks. But what they really need to do is orchestrate a major shift in the country’s economy. China needs to stop being a place that makes cheap shoes, and start being a place in which consumers prop up the economy, not just at home, but around the rest of the world. It’s not just China’s job to rebalance–the US and Europe have to do so as well–but if China doesn’t, nobody else can. The global economy is a closed loop. What’s more, the shift China needs to make is a very tough act (only three other Asian nations have managed it) particularly for an autocracy. It’s not at all clear yet that China can pull it off.'

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