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11/16/2015

IsthiswhytheUSisdelayinginterestraterises?AgendaTheWorldEconomicForum

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IsthiswhytheUSisdelayinginterestraterises?
ByBarryEichengreen
Nov102015

ThisarticleispublishedincollaborationwithProjectSyndicate.
Formuchoftheyear,investorshavebeenfixatedonwhentheFedwillachieve
liftoffthatis,whenitwillraiseinterestratesby25basispoints,or0.25%,asa
firststeptowardnormalizingmonetaryconditions.Marketshavesoaredand
plummetedinresponsetosmallchangesinFedstatementsperceivedasaffecting
thelikelihoodthatliftoffisimminent.
But,inseekingtogaugechangesinUSmonetaryconditions,investorshavebeen
lookinginthewrongplace.SincemidAugust,whenChinesepolicymakersstartled
themarketsbydevaluingtherenminbiby2%,Chinasofficialinterventioninforeign
exchangemarketshascontinued,inordertopreventthecurrencyfromfalling
further.TheChineseauthoritieshavebeensellingforeignsecurities,mainlyUnited
StatesTreasurybonds,andbuyinguprenminbi.
ThisistheoppositeofwhatChinadidwhentherenminbiwasstrong.Backthen,
ChinaboughtUSTreasurybondstokeepthecurrencyfromrisinganderodingthe
competitivenessofChineseexporters.Asaresult,itaccumulatedanastounding$4
trillionofforeignreserves.
AndwhatwastrueofChinawasalsotrueofotheremergingmarketcountries
receivingcapitalinflows.Thesecountriesforeignreserves,mainlyheldinUS
securities,topped$8trillionattheirpeaklastyear.

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Source:VisualCapitalist
Theeffectsofthesepurchasesattractedconsiderableattention.In2005,USFederal
ReserveChairAlanGreenspanpointedtothephenomenonasanexplanationforhis
famousconundrum:interestratesonTreasurybondswerelowerthanmarket
conditionsappearedtowarrant.Hissuccessor,BenBernanke,similarlypointedto
purchasesofUSdebtbyforeigncentralbanksandgovernmentsasareasonwhy
Americaninterestratesweresolow.
Nowthisprocesshasgoneintoreverse.AlthoughnooneoutsideofficialChinese
circlesknowstheexactmagnitudeofChinasforeignexchangeintervention,
informedguessessuggestthatithasbeenrunningatroughly$100billionamonth
sincemidAugust.Observersbelievethatroughly60%ofChinasliquidreservesare
inUSTreasurybills.Giventhatreservemanagersprefertoavoidunbalancingtheir
carefullycomposedportfolios,theyprobablyhavebeensellingTreasuriesatarate
ofroughly$60billionamonth.
Theeffectsareanalogousbutoppositetothoseofquantitativeeasing.Recall
thattheFedbeganitsthirdroundofquantitativeeasing(QE3)bypurchasing$40
billionofsecuritiesamonth,beforeboostingthevolumeto$85billion.Monthlysales
of$60billionbyChinasgovernmentwouldliesquarelyinthemiddle.Estimatesof
theeffectsofQE3differ.ButtheweightoftheevidenceisthatQE3hadamodest
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butsignificantdownwardimpactonTreasuryyieldsandapositiveeffectondemand
forriskierassets.
MenzieChinnoftheUniversityofWisconsinhasexaminedtheimpactofforeign
purchasesandsalesofUSgovernmentsecuritiesontenyearTreasuryyields.
Hisestimatesimplythatforeignsalesatarateof$60billionpermonthraiseyields
bytenbasispoints.GiventhatChinahasbeenatitfor2.5months,thisimpliesthat
theequivalentofa25basispointincreaseininterestrateshasalreadybeeninjected
intothemarket.
SomewouldobjectthattherenminbiisweakbecauseChinaisexperiencingcapital
outflowsbyprivateinvestors,andthatsomeofthisprivatemoneyalsoflowsintoUS
financialmarkets.Thisistechnicallycorrect,butitisalreadyfactoredintothe
changesininterestratesdescribedabove.Recallthatcapitalalsoflowedoutofthe
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USwhentheFedwasengagedinQE,withoutvitiatingtheeffects.Thatwaswhat
theearlierdebateovercurrencywarswhenemergingmarketscomplainedabout
beinginundatedbyfinancialinflowsfromtheUSwasallabout.
AnotherobjectionisthatQEoperatesnotjustthroughthesocalledportfoliochannel
bychangingthemixofsecuritiesinthemarketbutalsothroughtheexpectations
channel.Itsignalsthattheauthoritiesareseriouslycommittedtomakingthefuture
differentfromthepast.ButifChineseinterventionisjustaoneoffevent,andthere
arenoexpectationsofitcontinuing,thenthissecondchannelshouldntbeoperative,
andtheimpactwillbesmallerthanthatofQE.
TheproblemisthatnooneknowshowlongcapitaloutflowsfromChinawillpersist
orhowlongtheChineseauthoritieswillcontinuetointervene.Fromthisstandpoint,
theFedsdecisiontowaittobeginliftoffiseminentlysensible.And,giventhatChina
holds(andisthereforenowselling)eurosaswell,theEuropeanCentralBankalso
shouldbearthisinmindwhenitdecidesinDecemberwhethertorampupitsown
programofquantitativeeasing.
PublicationdoesnotimplyendorsementofviewsbytheWorldEconomicForum.
TokeepupwiththeAgendasubscribetoourweeklynewsletter.
Author:BarryEichengreenisProfessorofEconomicsattheUniversityofCalifornia,
Berkeley.
Image:TheUnitedStatesFederalReserveBoardbuildingisshownbehindsecurity
barriers.REUTERS/GaryCameron.
PostedbyBarryEichengreen10:11
Allopinionsexpressedarethoseoftheauthor.TheWorldEconomicForumBlogisanindependentandneutralplatform
dedicatedtogeneratingdebatearoundthekeytopicsthatshapeglobal,regionalandindustryagendas.
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