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As Federal Reserve officials gear up for the Jackson Hole symposium, their response to the pandemic is being criticized as risky by counterparts in Beijing who are trying to decouple China’s monetary policy from the U.S.
The Communist party’s politburo has pledged “greater autonomy” of macroeconomic policies, signaling a willingness to add stimulus as China’s recovery loses steam even if the Fed starts tapering bond purchases.
Meantime, China’s central bank is far more worried that America’s unprecedented stimulus since the pandemic will lead to a surge in U.S. inflation than the Fed’s benign view.
China’s financial sector opening and its economy’s out-performance during the pandemic has sparked an unprecedented inflow of global capital into its asset markets. That flood of foreign money increases the interdependence of monetary policy in the world’s two largest economies, because it could reverse if investors decide they can get better returns in America.
Previously, and as recently as 2016, Beijing could slam the brakes on any capital outflows with edicts capping or even banning them. But that was mainly to keep domestic money at home, not to trap global investors in. Authorities now are reluctant to reverse their hard-won market opening, which is crucial to modernizing the nation’s $56 trillion financial sector.
So with stronger capital constraints now less likely, something else will have to budge if the quest for monetary autonomy means China adds stimulus even as the Fed withdraws it. And that something, according to analysts, is the currency.
“China can use the exchange rate to deal with the external pressure,” said Larry Hu, China economist at Macquarie Group Ltd. “If the dollar strengthens, the yuan can weaken to absorb the shock.”
Depreciation would be risky, putting more pressure on already credit-strained Chinese companies with dollar-denominated debt and also running the risk of a self-reinforcing cycle of capital outflows similar to what happened after a poorly communicated move to weaken the yuan back in 2015. But the yuan is actually up 10% from its trade-war low in September 2019, giving the PBOC more wriggle room.
Fed Criticism
The U.S. faces the “most severe” inflation risks of any major economy due to the large deviation between the growth of its money supply and GDP since the pandemic, the People’s Bank of China said recently in its quarterly monetary policy report. On Tuesday, PBOC Governor Yi Gang said he’ll aim to match the expansion of money supply and nominal economic growth.
“A large amount of currency will inevitably lead to inflation,” the PBOC’s Aug. 9 quarterly report said. It added that the rapid growth in money supply would lead to “the destruction of financial discipline” and that the policies of the Fed and central banks in Europe and Japan will bring damaging side-effects.
“Since the pandemic, developed economies have launched massive fiscal and monetary stimulus, which has not only added to inflation pressure but also led to asset price bubbles, leading to a deviation of financial market trends from the real economy and exacerbated fragility. If the normalization of major economies’ monetary policy picks up, that could trigger a correction in financial markets, and increase capital outflow pressures and currency depreciation in most emerging economies, leading to higher risks for debt repayment and refinancing.”
— PBOC’s quarterly policy report
That reflects a common view among Chinese economists, who expect the Fed will need to tighten much faster than their U.S. peers predict.
“If the bubble in the American economy bursts after the pandemic, that will bring huge shocks to the world and the Chinese economy. We have to prevent and prepare for this scenario,” said Liu Yuanchun, a vice-president of Renmin University in Beijing who was part of a group of economists consulted by President Xi Jinping last year.
In some respects, the monetary autonomy push mirrors the wider effort by Xi’s administration to decrease its reliance on the U.S. for core technologies as it views Washington as an increasingly unreliable economic partner. Some economists see Beijing’s recent moves to rein-in large Chinese tech companies from listing overseas as part of that ambition too.
Most high-level economic exchanges between the U.S. and China have been suspended since the pandemic, complicating any prospect of synchronizing policies. The PBOC hasn’t sent representatives to Jackson Hole in recent years and isn’t on the speaker list this year either.
“The perception gap about U.S. inflationary risks could be the result of continued tensions and limited communication,” said Eswar Prasad, a former International Monetary fund head in China now at Cornell University.
The Jackson Hole topic this year is “Macroeconomic Policy in an Uneven Economy.” With the world’s two largest economies headed in different policy directions, that unevenness applies globally too.
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