China Doubts Cloud US Rate Decision

An analysis by Michael Lelyveld
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Federal Reserve chair Janet Yellen speaks at a conference in Washington, DC, after the Federal Reserve decided not to raise the key interest rate, Sept. 17, 2015.
Federal Reserve chair Janet Yellen speaks at a conference in Washington, DC, after the Federal Reserve decided not to raise the key interest rate, Sept. 17, 2015.

As China's economy shows signs of slowing, the effects are playing a greater role in economic policy decisions of the United States.

Last month, Federal Reserve chair Janet Yellen cited China's economic downturn as a consideration in the U.S. decision to delay raising interest rates.

Worries about China were seen as a key concern for the Fed in postponing the expected move to increase rates from near-zero for the first time in eight years.

At a Sept. 17 press conference, Yellen said that "some slowing in Chinese growth over time" had been anticipated as the country rebalances its economy. But misgivings about China had already moved beyond that stage.

“The question is whether or not there might be a risk of a more abrupt slowdown than most analysts expect,” she said.

Yellen cited a series of sharp market fluctuations in August, saying they "in part reflected concerns that ... there was downside risk to Chinese economic performance and perhaps concerns about the deftness with which policy-makers were addressing those concerns."

The comments raised significant issues on at least three counts.

First, U.S. policymakers have had to take the concerns about China's economy into consideration after weeks of volatility, reflecting greater importance than the usual variations in the market.

Second, U.S. regulators have had to weigh the effectiveness of China's economic management and uncertain consequences for world markets, as well as the United States.

Third, the remarks may be a measure of the rising impact of China's economy on U.S. and global markets, even as it grows at a diminished pace.

Dwight Perkins, Harvard University research professor of political economy and a leading China scholar, said the Fed concerns about China reflect its rise in influence on the world economy, commodity prices and trade.

"No question about it," Perkins said in a phone interview.

"Chinese demand has certainly played a significant role in sustaining high natural resource prices in a wide variety of natural resources and commodities," Perkins said.

"The slowdown and the shift in the structure of the Chinese economy together have greatly reduced that demand," he said.

With that, commodity prices have dropped, affecting inflation, which is the Federal Reserve's chief concern.

The Fed has been expected to act at the first sign that the improving U.S. economy is reviving inflation by raising rates off the zero-floor to head it off.

But with cooling demand in China, commodity prices have sagged, keeping inflation far below the Fed's 2-percent target for growth.

Focus on uncertain developments

Yellen has indicated that the long-awaited hike in the federal funds rate is still expected by the end of the year, although a weak U.S. jobs report last week could delay action further.

But the Fed's focus on uncertain developments in China may be unprecedented.

Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington, said the Federal Reserve has been historically reluctant to cite economic factors abroad as influencing its deliberations.

"However, Yellen mentioned China several times in this most recent statement, and it was the clearest acknowledgment that I've seen of external forces weighing very heavily on the Fed's decisions," Hufbauer said.

"The cloudiness over to what extent the Chinese economy is slowing down all weighed pretty heavily on the Fed's decision not to raise rates in September," he said.

The decision was not without its critics, however, particularly on the grounds of ambiguity about the Chinese economy and its role in U.S. policy considerations.

A Reuters report cited complaints from investors "who believe the U.S. rate cycle and global markets are now hostage to Chinese fortunes."

Most voiced impatience with the market uncertainty of waiting for the Fed to act on rates, a condition of limbo that has been compounded by questions about Chinese economic management and growth.

"The thought of having to monitor China's notoriously opaque policy-making process to get a better reading of Fed policy and global liquidity has left investors flustered and dismayed," Reuters said.

Investors have been wary since Aug. 11, when the People's Bank of China (PBOC) stunned world markets with a "one-off" devaluation of the yuan by nearly 2 percent, which then threatened to spin out of control in subsequent trading.

The surprise move on the currency shook world markets, sparking a selloff of stocks and fears of instability around the globe.

Confidence was further shaken by a series of unpredictable rules changes for investors in China after a near-40 percent slide in stock market prices since July.

The greatest uncertainty

But the greatest uncertainty has centered on the state of China's economy and widespread skepticism over the official claims that the growth of gross domestic product (GDP) has held steady at 7 percent.

Doubters point to a slew of indicators like industrial output and electricity consumption that suggest weaker performance. In the first eight months of the year, power use edged up only 1 percent, according to the National Energy Administration (NEA).

Perkins dismissed the suspicions of GDP data inflation, arguing that critics have given short shrift to the growth of services and their contribution to GDP growth after decades of lagging behind.

While growth in the industrial sector has cooled, the less energy-intensive service sector rose 8.4 percent from a year earlier in the first half to account for 49.5 percent of GDP, according to official figures.

The service sector used 12.9 percent of China's electricity in the first eight months. While the secondary industry, or manufacturing, accounted for 43.6 percent of GDP in the first half, it consumed 71.8 percent of the power in the eight-month period.

Analysts have challenged China's GDP estimates with calculations based on power consumption data and other indicators in the past, but Perkins said their work is "just wrong."

"These people fade from the scene and their work is long forgotten," he said.

But doubts about the data aside, the nontransparency of China's decision-making have become an issue for world markets and U.S. economic policy.

"We regard the transparency of Chinese economic decisions as lacking. It could be much, much better," said Hufbauer.

"It's all much more opaque than it should be, and it does lead to considerable fears in the Western press that China has a lot to hide," he said. "I think the lack of transparency actually hurts China in terms of its economic policy."

On China's side, the official press seemed to breathe a sigh of relief at the U.S. delay in the rate hike after weeks of trying to blame the pending decision for stock market tremors due to fears of capital outflow.

Chinese reports have raised concerns that the decline in PBOC foreign exchange reserves may accelerate if the Fed turns the tide on interest rates with an increase on the U.S. side.

On Sept. 18, the official Xinhua news agency said in a commentary that the postponement "has given emerging markets, including China, some breathing room, but the Fed must stay cautious of the havoc a future rate hike could cause."

Hufbauer said he had met recently with senior Chinese officials who voiced nervousness about the consequences.

But the effect on China's ample reserves is unlikely to be a concern for U.S. rate decisions.

"I don't think the Fed would give a hoot if there was more outflow from China in terms of foreign exchange," Perkins said.





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