How US inflation spiral could tip superpower rivalry in China’s favour
- China’s financial system could soon be strong enough to withstand a stronger yuan, leaving the US vulnerable to a currency shock
- Floating the renminbi could tip the US deeper into inflation and turmoil while giving Beijing free rein in international affairs
This will further entrench the inflation cycle and pile up the risks down the road. If the dollar-renminbi peg breaks – which China could bring about deliberately as a strategic move – the consequences could be catastrophic for the United States. If and when that day comes, know that the Fed is responsible.
The Fed, on the other hand, is sticking to its story that inflation is transitory, blaming supply chain disruptions such as congestion at ports and a lack of workers.
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This has been to China’s benefit. It increases outsourcing of manufacturing, which boosts China’s industrialisation, and corrupts the US ruling elite with massive gains in paper wealth. It will become advantageous for China to remove the currency peg at some point, though, and the conditions for that are coming to a boil.
The Fed’s loose monetary policy has weakened the US for decades, substituting competitiveness with cheap debt to sustain living standards. This can be seen in the country’s rising trade deficit and stagnant wages, leaving the underlying rot to continue to pile up.
The US system has not crashed because the currency peg channels the productivity of Chinese workers into supporting the US dollar. By letting inflation take hold, the Fed has given Beijing a chance to tip it over. It has not taken that chance because China is not yet strong enough to withstand a crash like the US saw in 2008.
A bubble bursting in slow motion might sound like an oxymoron, but Beijing can do just that because of its ability to manipulate market expectations. It can periodically convince the market that the government will not really burst any bubbles, encouraging speculators to hold on and avoid a stampede to safety. By the time speculators wake up, it will be too late to sell.
Beijing’s decision to deflate the bubble is driven by three factors. First, US-China rivalry has driven up the cost of a crisis, which would cripple the country’s ability to compete. The property bubble is already big enough to bring down China’s financial system, and further expansion would make it impossible to manage its deflation.
Finally, the property bubble’s usefulness is eroding. It is really a tax on housing to finance infrastructure construction and urbanisation, both of which have gone far enough already. Slowing down in this area won’t be so damaging for the economy. Rather, the bubble bursting is a big tax cut for the household sector and will benefit consumption in the long run.
In short, China is getting its fiscal house in order while the Fed lets inflation run rampant, increasing China’s leverage over the US. If the US wants to compete with China, it must start by changing the Fed’s approach.
Andy Xie is an independent economist