Nov 10th 2015

Is US Monetary Policy Made in China?

by Barry Eichengreen

Barry Eichengreen is Professor of Economics at the University of California, Berkeley.

AMSTERDAM – For much of the year, investors have been fixated on when the Fed will achieve “liftoff” – that is, when it will raise interest rates by 25 basis points, or 0.25%, as a first step toward normalizing monetary conditions. Markets have soared and plummeted in response to small changes in Fed statements perceived as affecting the likelihood that liftoff is imminent.

But, in seeking to gauge changes in US monetary conditions, investors have been looking in the wrong place. Since mid-August, when Chinese policymakers startled the markets by devaluing the renminbi by 2%, China’s official intervention in foreign-exchange markets has continued, in order to prevent the currency from falling further. The Chinese authorities have been selling foreign securities, mainly United States Treasury bonds, and buying up renminbi.

This is the opposite of what China did when the renminbi was strong. Back then, China bought US Treasury bonds to keep the currency from rising and eroding the competitiveness of Chinese exporters. As a result, it accumulated an astounding $4 trillion of foreign reserves.

And what was true of China was also true of other emerging-market countries receiving capital inflows. These countries’ foreign reserves, mainly held in US securities, topped $8 trillion at their peak last year.

The effects of these purchases attracted considerable attention. In 2005, US Federal Reserve Chair Alan Greenspan pointed to the phenomenon as an explanation for his famous “conundrum”: interest rates on Treasury bonds were lower than market conditions appeared to warrant. His successor, Ben Bernanke, similarly pointed to purchases of US debt by foreign central banks and governments as a reason why American interest rates were so low.

Now this process has gone into reverse. Although no one outside official Chinese circles knows the exact magnitude of China’s foreign-exchange intervention, informed guesses suggest that it has been running at roughly $100 billion a month since mid-August. Observers believe that roughly 60% of China’s liquid reserves are in US Treasury bills. Given that reserve managers prefer to avoid unbalancing their carefully composed portfolios, they probably have been selling Treasuries at a rate of roughly $60 billion a month.

The effects are analogous – but opposite – to those of quantitative easing. Recall that the Fed began its third round of quantitative easing (QE3) by purchasing $40 billion of securities a month, before boosting the volume to $85 billion. Monthly sales of $60 billion by China’s government would lie squarely in the middle. Estimates of the effects of QE3 differ. But the weight of the evidence is that QE3 had a modest but significant downward impact on Treasury yields and a positive effect on demand for riskier assets.

Menzie Chinn of the University of Wisconsin has examined the impact of foreign purchases and sales of US government securities on ten-year Treasury yields. His estimates imply that foreign sales at a rate of $60 billion per month raise yields by ten basis points. Given that China has been at it for 2.5 months, this implies that the equivalent of a 25-basis-point increase in interest rates has already been injected into the market.

Some would object that the renminbi is weak because China is experiencing capital outflows by private investors, and that some of this private money also flows into US financial markets. This is technically correct, but it is already factored into the changes in interest rates described above. Recall that capital also flowed out of the US when the Fed was engaged in QE, without vitiating the effects. That was what the earlier debate over “currency wars” – when emerging markets complained about being inundated by financial inflows from the US – was all about.

Another objection is that QE operates not just through the so-called portfolio channel – by changing the mix of securities in the market – but also through the expectations channel. It signals that the authorities are seriously committed to making the future different from the past. But if Chinese intervention is just a one-off event, and there are no expectations of it continuing, then this second channel shouldn’t be operative, and the impact will be smaller than that of QE.

The problem is that no one knows how long capital outflows from China will persist or how long the Chinese authorities will continue to intervene. From this standpoint, the Fed’s decision to wait to begin liftoff is eminently sensible. And, given that China holds (and is therefore now selling) euros as well, the European Central Bank also should bear this in mind when it decides in December whether to ramp up its own program of quantitative easing.


Barry Eichengreen is a professor at the University of California, Berkeley, and the University of Cambridge. His latest book is Hall of Mirrors: The Great Depression, the Great Recession, and the Uses – and Misuses – of History.

Copyright: Project Syndicate, 2015.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Jan 24th 2020
EXTRACT: "........while over 80% of the ECB scheme buys government and other public sector bonds, a huge chunk still goes into corporate bonds and other assets. At the time of writing, the ECB holds €263 billion worth of corporate bonds – a very significant amount in relation to individual firms and the sectors in question. According to the ECB, 29% of these bonds were issued by French firms, 25% by German firms and 11% each by Spanish and Italian firms. As at September 2017, the sectors they came from included utilities (16%), infrastructure (12%), automotive (10%) and energy (7%)."
Jan 17th 2020
EXTRACT: "Thanks to cutting-edge digital technology, cars are increasingly like “smartphones on wheels”, so manufacturers need to have access to the latest patented 4G and 5G technologies essential to navigation and communications. But often the companies that hold the patents are reluctant to license them because manufacturers will not accept the high fees involved, which leads to patent disputes and licensing rows."
Jan 13th 2020
EXTRACT: "Recent polling from Pew Research demonstrates how the public’s attitudes toward the US and President Trump have witnessed sharp declines in many nations across the world. In Europe, the Americas, and the Middle East favorable attitudes toward the US went from lows during the years of George W. Bush’s presidency to highs in the early Obama years to lows, once again, in the Trump era. And in our Zogby Research Services (ZRS) polling we found, with a few exceptions, much the same trajectory across the Middle East."
Jan 13th 2020
EXTRACT: "In the absence of a declaration of war against Iran, the killing of a foreign official – by a drone strike on Iraqi territory – was possibly illegal. But such niceties do not perturb Trump. The evidence is that Trump’s decision was taken without consideration of the possible consequences. The national security system established under Dwight D. Eisenhower, designed to prevent such reckless measures, is broken to non-existent, with ever-greater power placed in the hands of the president. If that president is unstable, the entire world has a very serious problem."
Jan 9th 2020
EXTRACT: "It is possible that Trump’s reverential base won’t be sufficient to keep him in the White House past 2020. But such ardent faith is hard to oppose with rational plans to fix this or that problem. That is why it is so unsettling to hear people at the top of the US government speak about politics in terms that rightly belong in church. They are challenging the founding principles of the American Republic, and they might actually win as a result."
Jan 7th 2020
EXTRACT: "If anything has become clear in our recent Zogby Research Services (ZRS) polling in Iraq, is that most Iraqis are tired of their country being used as a playground for regional conflict, especially the conflict between the US and Iran. In fact, our polling has shown Iraqis increasingly upset with the role played by both the US and Iran in their country. Majorities see both of these countries as having been the major beneficiaries of the wars that have ravaged their nation since the US invaded in 2003. "
Jan 5th 2020
EXTRACT: "Under his [Suleimani's] leadership, Iran helped Hezbollah beef up its missile capabilities, led a decisive intervention to prop up Syrian President Bashar al-Assad, supported the Houthi rebels who have been waging a war against Saudi-led forces in Yemen, and backed a wave of resurgent Shia militias in Iraq. According to Gadi Eizenkot, who completed his term as the Israel Defense Forces’ chief of general staff last year, Suleimani had plans to amass a proxy force of 100,000 fighters along Syria’s border with Israel."
Dec 31st 2019
EXTRACT: ".....stunning technological progress during the 2010s makes it possible to cut GHG emissions at a cost far lower than we dared hope a decade ago. The costs of solar and wind power have fallen more than 80% and 70%, respectively, while lithium-ion battery costs are down from $1,000 per kilowatt-hour in 2010 to $160 per kWh today. These and other breakthroughs guarantee that energy systems which are as much as 85% dependent on variable renewables could produce zero-carbon electricity at costs that are fully competitive with those of fossil-fuel-based systems."
Dec 31st 2019
EXTRACT: "Predicting the next crisis – financial or economic – is a fool’s game. Yes, every crisis has its hero who correctly warned of what was about to come. And, by definition, the hero was ignored (hence the crisis). But the record of modern forecasting contains a note of caution: those who correctly predict a crisis rarely get it right again. The best that economists can do is to assess vulnerability. Looking at imbalances in the real economy or financial markets gives a sense of the potential consequences of a major shock. It doesn't take much to spark corrections in vulnerable economies and markets. But a garden-variety correction is far different from a crisis. The severity of the shock and the degree of vulnerability matter: big shocks to highly vulnerable systems are a recipe for crisis. In this vein, the source of vulnerability that I worry about the most is the overextended state of central-bank balance sheets. My concern stems from three reasons."
Dec 14th 2019
EXTRACT: "Conspiracy theories about sinister Jewish power have a long history. The Protocols of the Elders of Zion, a Russian forgery published in 1903, popularized the notion that Jewish bankers and financiers were secretly pulling the strings to dominate the world. Henry Ford was one of the more prominent people who believed this nonsense."
Dec 13th 2019
EXTRACT: "In previous British elections, to say that trust was the main issue would have meant simply that trust is the trump card – whichever leader or party could secure most trust would win. Now, the emerging question about trust is whether it even matters anymore."
Dec 5th 2019
EXTRACT: "Europe must fend for itself for the first time since the end of World War II. Yet after so many years of strategic dependence the US, Europe is unprepared – not just materially but psychologically – for today’s harsh geopolitical realities. Nowhere is this truer than in Germany."
Nov 23rd 2019
Extdact: "The kind of gratitude expressed by Vindman and my grandfather is not something that would naturally occur to a person who can take his or her nationality for granted, or whose nationality is beyond questioning by others. Some who have never felt the sharp end of discrimination might even find it mildly offensive. Why should anyone be grateful for belonging to a particular nation? Pride, perhaps, but gratitude? In fact, patriotism based on gratitude might be the strongest form there is."
Nov 20th 2019
Extract: "Moody’s, one of the big three credit rating agencies, is not upbeat about the prospects for the world’s debt in 2020 – to put it mildly. If we were to try to capture the agency’s view of where we are heading on a palette of colours, we would be pointing at black – pitch black."
Nov 17th 2019
Extract: "Digital money is already a key battleground in finance, with technology firms, payment processing companies, and banks all vying to become the gateway into the burgeoning platform-based economy. The prizes that await the winners could be huge. In China, Alipay and WeChat Pay already control more than 90% of all mobile payments. And in the last three years, the four largest listed payment firms – Visa, Mastercard, Amex, and PayPal – have increased in value by more than the FAANGs (Facebook, Apple, Amazon, Netflix, and Google)."
Nov 14th 2019
Extract: "Trump, who understands almost nothing about governing, made a major mistake in attacking career public officials from the outset of his presidency. He underestimated – or just couldn’t fathom – the honor of people who could earn more in the private sector but believe in public service. And he made matters worse for himself as well as for the government by creating a shadow group – headed by the strangely out-of-control Rudy Giuliani, once a much-admired mayor of New York City, and now a freelance troublemaker serving as Trump’s personal attorney – to impose the president’s Ukraine policy over that of “the bureaucrats.” "
Nov 4th 2019
Extract: "Trump displays repeated and persistent behaviours consistent with narcissistic personality disorder and antisocial personality disorder. These behaviours include craving for adulation, lack of empathy, aggression and vindictiveness towards opponents, addiction to lying, and blatant disregard for rules and conventions, among others." The concern is that leaders with these two disorders may be incapable of putting the interests of the country ahead of their own personal interests. Their compulsive lying may make rational action impossible and their impulsiveness may make them incapable of the forethought and planning necessary to lead the country. They lack empathy and are often motivated by rage and revenge, and could make quick decisions that could have profoundly dangerous consequences for democracy.
Oct 31st 2019
EXTRACT: "......let’s see what happens when we have less money for all the things we want to do as a country and as individuals. Promises and predictions regarding Brexit will soon be tested against reality. When they are, I wouldn’t want to be one of Johnson’s Brexiteers."
Oct 21st 2019
EXTRACT: "Were Israel to be attacked with the same precision and sophistication as the strike on Saudi Arabia, the Middle East would be plunged into war on a scale beyond anything it has experienced so far. Sadly (but happily for Russian President Vladimir Putin), that is the reality of a world in which the US has abandoned any pretense of global leadership."
Oct 20th 2019
EXTRACT: "Europe also stands to lose from Trump’s abandonment of the Kurds. If, in the ongoing chaos, the thousands of ISIS prisoners held by the Kurdish-led Syrian Democratic Forces escape – as some already have – America’s estranged European allies will suffer. Yet Trump is unconcerned. “Well, they are going to be escaping to Europe, that’s where they want to go,” he remarked casually at a press conference. “They want to go back to their homes." "