US-China Watch

With the world in flux as never before, macroeconomic insight and analysis is always at risk of chasing a moving target. That is especially the case when it comes to the US-China conflict, driven by the oft unpredictable crosscurrents between the world’s two largest economies and their ambitious geostrategic aspirations. Through the combination of blogging and tracking the rapidly shifting news flow, the weekly updates below will attempt to keep you abreast of the latest developments on the US-China watch.

Fed Risks and China

It is tempting to give America’s Federal Reserve great credit for its recent about-face in tackling inflation.  Three consecutive rate hikes of 75 bps in the federal funds rate (FFR) represent the sharpest increase in the benchmark policy rate over a four-month time span since early 1982. Yes, but…

The real problem is that the Fed is digging itself out of the deepest hole it has ever been in.  The nominal FFR, now effectively at 3.1%, remains five full percentage points below the 3-month average of the headline CPI inflation rate (which averaged 8.4% y/y in July and August and most likely was in the 7.5% to  8% zone in September).  Inflation control is all but impossible with a sharply negative “real” federal funds rate of around -5%.

Fed Chair Powell has been explicit in stressing that monetary policy needs to be restrictive to accomplish that task.  What defines a restrictive monetary policy? Sticking with my definition of the real federal funds rate based on the headline CPI, the neutral policy rate — basically an average of the real FFR from 1960 to 2021 — is +1.1%.  That is fully six percentage points above where the real FFR is today.  Restrictive, by definition, must be a number greater than neutrality — for the sake of argument, call it a 2% real FFR.  As noted above, with the real FFR at -5%, the Fed is not even close to being restrictive.

Here is where the debate gets tricky: Powell asserted during his September 21 press conference, that Fed policy is now in the “lower end of the restrictive zone.” He made that judgement on the basis of measuring underlying inflation by the so-called “core personal consumption deflator,” which excludes food and energy, and was running at 4.6% y/y through July.

This is disappointing for two reasons: One, the nominal FFR is still well below this measure of core inflation.  Two, the Fed’s core fixation is dangerous.  That was the case in the early 1970s, when I was part of the Fed’s staff that created the core, and it is the case today. The very premise of the core is to dismiss major price shocks as transitory, as Powell initially did. I am still haunted by the blunders of Arthur Burns in the early 1970s that fell for this ruse by chasing one transitory shock after another.  The lesson: A Fed that lives by the core, often dies by the core.

This is a long-winded way of saying that the Powell Fed has much further to go in digging out of the proverbial deep hole. I suspect that the nominal FFR will have to rise into the 5.5% to 6% zone to accomplish that task — implying that the Fed may only be about half done with its inflation-control campaign. That spells recession in the US economy in 2023, which reinforces the downturn already evident in Europe.  Export-dependent China, already in the midst of a sharp slowdown, is unlikely to be an oasis in that climate.  The blame game always intensifies in a global recession.  That doesn’t bode well for an already treacherous US-China conflict.

You can follow me on Twitter @SRoach_econ

TPA + IPEF = China Containment

Taking its cue from Nancy Pelosi’s early August visit to Taiwan, the US Congress continues to lead America’s squeeze play on China.  At the same time, the Biden Administration is not too far behind in continuing to pressure China.  The combination of these two...

read more

RMB Wildcard?

With the Chinese renminbi (RMB) approaching the seemingly key threshold of “7” relative to the US dollar, rumor-driven foreign exchange markets are on edge. Those fears are overblown for three key reasons: First, RMB management is the least of China’s current...

read more

Dodging a Bullet on Financial Conflict

The August 26 preliminary agreement between China’s CSRC (China Securities Regulatory Commission) and America’s PCAOB (Public Company Accounting Oversight Board) on cross-border audit inspections is welcome and encouraging news.  The well-telegraphed agreement was...

read more

Coalition of the Willing

It turns out that Speaker Pelosi’s visit to Taiwan in early August was the tip of a much larger iceberg. Not only was it immediately followed by a bipartisan congressional delegation led by US Senator Ed Markey (a Democrat) and then a subsequent visit by Indiana...

read more

Kurt Campbell’s Asian Pivot

Kurt Campbell, National Security Council Indo-Pacific Coordinator (aka Biden’s “Asia man”) has an important cameo role in Accidental Conflict.  As I note in the book, “In an earlier incarnation at the State Department, Campbell played a key tole in developing one of...

read more

Splitting Hairs on “One China”

The predictable blowback on my latest FT opinion piece fixated on misdirected efforts to provide justification for Nancy Pelosi’s pro-independence stance on Taiwan.  I cited the 1972 Shanghai Communiqué as providing the bedrock foundation for US acceptance of the “One...

read more

What Did Pelosi Accomplish?

Predictably, the Chinese have responded with a vengeance to House Speaker Nancy Pelosi’s August 2-3 chest-thumping visit to Taiwan. The Speaker’s remarks, which unexpectedly found me offering live color commentary at the time on CNBC Asia, played well in domestic...

read more

Taiwan Tensions

Henry Kissinger recently remarked in a fascinating interview that the United States has an unfortunate penchant for seeking “endless confrontations” with China. This resonates with a key theme of Accidental Conflict, which stresses the blame game as an inherent...

read more

Globalization with Chinese Characteristics?

China has been the greatest beneficiary of the current wave of globalization. In the decade prior to China’s 2001 accession to the World Trade Organization, Chinese exports averaged just 2% of total world exports. By 2021, that share had risen to 12.7%. China is...

read more

Zero Covid = Zero Growth

Largely in response to China’s so-called “dynamic zero-Covid” policy, official government statistics just revealed that the Chinese economy slowed to a virtual standstill in the second quarter of this year.  The increase of +0.4 % in real GDP is reported on a...

read more
Sign up for Stephen’s Dispatches: