The Chinese are trying to rein in a credit bubble. The trade tariffs coming on top of this tightening are likely to exacerbate the economy’s slowdown. This is especially worrying when the country is the main importer of commodities. The last time they stopped importing commodities almost half the world caught a cold. The same could happen this time.
By causing unfunded tax cuts, Trump has made life more difficult for the Federal Reserve, which is having to be more restrictive than it would otherwise be.
The Fed should be mindful that its decisions at home will have an impact overseas, particularly when these can precipitate economic crises.
America is the global economic power and the dollar is the world’s currency. The 2008 crisis showed this.
The Fed at that time eventually made swap lines available to the Chinese to resolve its dollar crisis. The huge spillover effects on the global economy, including America, make that essential.
This time, however, the Fed seems only mindful of conditions at home, in spite of several systemically important financial institutions in China. America should be helping to guard them, not the opposite, to avoid any spillover again.
Instead, the resultant combination of a higher dollar and high interest rates is causing an abrupt reversal of capital flows in emerging markets. And as the IMF pointed out recently, never have emerging markets been so indebted in relation to their output as they are today.
If the Chinese do let the currency go, there would be huge strains on other countries — Japan, South Korea and Australia for example — as well as the emerging markets. The net result could be dollar appreciation against virtually every other country, as these dominoes fall.
As Dumas says, the consequences for equity markets are not good and even the bond markets may have trouble. The US will be hit too. America First may be want Trump wants, but at what cost?
