The past week has shown us that the world economy is dominated more than ever by the symbiotic relationship of China and America.
Two years after the taper tantrum, this was the week of the Chimerican chill. Economist Moritz Schularick and I coined the word Chimerica in these pages in 2007, combining China and America, to describe the symbiotic relationship increasingly dominating the world economy. That is even truer now, as the past several days have shown. For the first time in financial history, a sneeze in Shanghai gave Wall Street—and almost every other stock market in the world—a cold.
Before the 2008 financial crisis, Chimerica was a marriage of opposites. China saved, exported and lent. America consumed, imported and borrowed. For a few heady years, the odd couple were happy together. Not only did the glut of Chinese savings lower the cost of capital, the glut of Chinese workers reduced the cost of labor. Every asset class on the planet rallied.
But the unbalanced economic relationship between China and America posed a threat to global financial stability. That was our point in 2007: Chimerica was a chimera. Without the flow of Chinese savings into U.S. dollars back then, a result of Beijing’s large-scale intervention to keep its currency weak, American interest rates would surely have been higher and the U.S. housing bubble less inflated. Surprisingly, the 2008 financial crisis didn’t lead to a Sino-American divorce, despite mutual accusations of monetary manipulation. Instead, like any couple who spend long enough in each other’s company, the Chimericans grew ever more alike.
China took steps to make its economy less state-led and export-driven, and more market-led and consumption-driven. But it also picked up some bad American habits. China’s economy became dangerously reliant on easy money and mounting debt, and prone to bubbles, beginning with urban real estate. Growth slowed and inequality rose.
For these reasons, we continued to worry about Chimerica. “If monetary policy is too loose for too long,” we wrote in a November 2013 article for the Journal, “history suggests it can increase the probability of a disorderly asset-price crash. It is not hard to imagine such a scenario in a China that has acquired American levels of leverage, plus a bunch of shaky shadow banks.”
Timing would be key. Several months earlier, when the Federal Reserve announced that it would wind down its bond-buying, the markets had reacted badly, as traders tried to “price in” the effects of tighter Fed policy. In the wake of this “taper tantrum” we worried that if Beijing and Washington tried to exit easy money at the same time, “the global economy could take a big hit”—especially emerging markets with large current-account deficits. “Coordination and sequencing are therefore essential,” we concluded.
In the past few days, the consequences of such a double whammy have become clear: the concurrence of the Chinese equities bust with voices from the Federal Reserve signaling an interest-rate “lift off” this year led to another investor tantrum, with emerging markets again bearing the brunt.
It wasn’t until Wednesday that the Fed, in the person of New York Fed President William Dudley, tamped down rate-increase expectations, prompting a relief rally on Wall Street. For lift-off watchers, December is the new September.
Much less predictable is what Beijing will do. After the bursting of the stock bubble in June, the Chinese government resorted to a bewildering combination of market interventions, exhorting pension funds to buy and threatening sellers with prosecution. These measures have not only failed, they have also damaged the government’s credibility.
Such blunt instruments must be set aside, and the role of the People’s Bank of China (PBOC) redefined so that it becomes more Fed-like in character. China’s leaders need to see that regardless of the Fed’s official dual mandate—to promote stable prices and maximum employment—responsibility for preventing an asset-price crash lies with the central bank alone.
China took the first step in this direction on Monday with the announcement after the close of the Chinese markets that the PBOC was immediately reducing its benchmark one-year lending rate by 25 basis points to 4.6%, as well as cutting the one-year savings rate and lowering the reserve requirement ratio for banks.
But the bigger story this month has been the PBOC’s abandonment of the de facto link between the yuan and the U.S. dollar, heralded by the devaluation of the yuan announced Aug. 11.
These measures should be welcomed by investors as evidence that the PBOC is now leaning against, rather than with, the wind. Yet a mystery remains: Who exactly is calling the monetary shots in Beijing?
A major problem has been the over-readiness of President Xi Jinping to identify himself with economic policy, to the extent that state media seemed to equate the stock market rally in the first half of the year with Mr. Xi’s “Chinese Dream”—a set of aspirations for national rejuvenation. True, Mr. Xi has put Premier Li Keqiang out in front of the government’s response to the stock-market crash. This makes sense in two ways: Formally, all major PBOC actions must literally be signed by the premier. Politically, Mr. Xi is giving himself the option to blame Mr. Li if things go wrong.
What would help is a clear statement to the effect that the PBOC is in charge of Chinese monetary policy. Mr. Xi cannot be expected to proclaim the PBOC’s independence, but he should publicly assert its primacy over other government agencies. One reason markets have been so rattled is the perception that behind the façade of presidential power an ugly turf war is being fought between the PBOC and other agencies, notably the China Securities Regulatory Commission. Despite the international respect that the PBOC’s veteran governor, Zhou Xiaochuan, has earned, he and his senior staff still lack the authority of their Western counterparts.
The good news is that, if its authority is firmly established, the PBOC has the capacity to repair the damage. The bad news is that the future of Chimerica—and the world economy—is now more dependent than ever on the expedients of central bankers. Get ready for more quantitative easing, but this time with Chinese characteristics.
