That is the crucial economic backdrop to Xi’s warning to the global financial elite at the World Economic Forum that Western central banks must not raise interest rates too aggressively because tighter monetary policy could hurt emerging market economies.
“If major economies slam on the brakes or take a U-turn in monetary policies, there will be serious spillovers that will present challenges to global economic and financial stability, and developing countries will bear the brunt of it,” Xi said.
Xi’s rhetoric may be the latest attempt to undermine the credibility of US global institutions and the US dollar as the world’s reserve currency.
China is rapidly moving to develop a renminbi-denominated central bank digital currency to erode the power of the US dollar.
Yet, the case for tighter US monetary policy is compelling. US inflation is at a high 7 per cent and the Fed’s interest rate is anchored at zero.
The real (inflation adjusted) interest rate is negative 7 per cent.
Monetary policy is too loose and the Fed is at risk of being too far behind an inflation outbreak.
The Washington-based Fed is expected to deliver three or four interest rate rises this year, starting lift-off as soon as March.
Ironically, China’s zero-COVID policy is exacerbating US inflation.
COVID-19 outbreaks are periodically causing China to restrict activity in the world’s manufacturing hub, slowing the export of in-demand goods to the consumer-driven US.
Constraints on supply from China are colliding with stimulus-fuelled US demand.
China may be slightly susceptible to rising US interest rates and a consequent stronger US dollar, because Beijing manages its exchange rate with reference to the US dollar.
But Beijing operates a controlled capital account and has huge foreign exchange reserves, so the direct impact on China is likely to be limited.
Other emerging markets are nervous about the Fed’s tightening cycle – a factor Xi alluded to.
Rising US interest rates have in the past hurt emerging market economies, such as during the 2013 “taper tantrum” when the then Fed chairman Ben Bernanke tried to withdraw its asset purchase program.
Investors punished emerging markets by withdrawing capital and weakening their currencies in favour of perceived safe havens such as the US.
Perhaps Xi’s message was partly aimed at emerging markets. In its geopolitical power struggle with the US, China is trying to court emerging market governments, including several in Australia’s region in south-east Asia as well as Latin America.
But emerging markets, such as Indonesia, are now better prepared to withstand a Fed tightening, due to higher foreign currency reserves and stronger financial systems.
Moreover, at the same event five years ago, Xi in person at Davos – rhetorically – embraced globalisation in the face of Donald Trump’s trade war, telling a receptive business audience that “pursuing protectionism is like locking oneself in a dark room”.
Alas, China has since turned more inward, hitting Australian exporters with trade sanctions and cracking down on its large companies operating in technology, education and property to achieve “common prosperity”.
Xi’s economic rhetoric doesn’t always live up to the headlines.
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