The world’s two biggest economies have failed to learn the lessons of over-investing and what happens when funding costs rise.
US tightening could hurt developing countries at this delicate time. That, of course, is perfectly correct and has always been thus. But it would be worse to let inflation in the US form into a wage-price spiral. This would result in even higher interest rates in the end. And the Fed is already so very late.China does not have open capital markets and because of this most currency trading in the yuan occurs offshore in a shadow market.
With US interest rates at zero and China tightening after the ill-advised credit boom that followed the GFC, the exchange rate was allowed to appreciate vis the dollar for prolonged periods. The US failed to sustain this 2017-19 attempt to raise interest rates and taper QE, and quickly reverted to its
The prospect now, however, is for US tightening. This will likely remove that interest rate differential, particularly with China trying to cut rates at the same time. Research shows that for China’s foreign borrowing companies, a depreciation of the yuan would cost more in servicing costs than the companies would gain via trade, and particularly if they are real estate companies that aren’t exporting anything.
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