The EM sell-off and China as a global monetary superpower

This is what I just told Ambrose Evans-Pritchard at the Telegraph:

“We have all these countries in trouble like Argentina, Ukraine and Thailand that are each local cases, but behind the whole emerging market story is Fed tapering and worries about slowing Chinese growth…China is now a global monetary superpower, co-leader with the US. When China tightens, that hits trade and commodities across the world.”

…and about the emergency monetary policy meeting of the Turkish central bank (coming up late Tuesday):

“Danske Bank said the Turkish authorities may have to raise rates by 200 to 300 basis points to placate the markets, a shock treatment that risks going badly wrong. “They are tightening to defend their currency, and in doing so killing the economy. In the end they will be forced to give up. There is the same risk in India,” said Mr Christensen.”

This is essentially the same message I also spelled out in my post yesterday – “Please don’t fight it – the risk of EM policy mistakes”

Sino-monetary transmission mechanism

I have talked and written about China as a global monetary superpower before and I think it is useful to repeat (part of) this story to help better understand what presently is going on in Emerging Markets.

David Beckworth has argued (see for example here) that the Federal Reserve is a monetary superpower as “it manages the world’s main reserve currency and many emerging markets are formally or informally pegged to dollar. Thus, its monetary policy gets exported to much of the emerging world. “

I believe that the People’s Bank of China to a large extent has the same role – maybe even a bigger role for some Emerging Markets particularly in Asia and among commodity exporters. Hence, the PBoC can under certain circumstances “dictate” monetary policy in other countries – if these countries decide to import monetary conditions from China.

Overall I see three channels through which PBoC influence monetary conditions in the rest of the world:

1) The export channel: For many countries in the world China is now the biggest or second biggest export market. So a monetary induced slowdown in the Chinese economy will have significant impact on many countries’ export performance. This is the channel most keynesian trained economists focus on.

2) Commodity price channel: As China is a major commodity consumer Chinese monetary policy has a direct impact on the demand for and the price of commodities. So tighter Chinese monetary policy is causing global commodity prices to drop. This obviously is having a direct impact on commodity exporters. See for example my discussion of Chinese monetary policy and the Brazilian economy here.

3) The financial flow channel: China has the largest currency reserves in the world . This means that China obviously is extremely important for demand for global financial assets. A contraction in Chinese monetary policy will reduce Chinese FX reserve accumulation and as a result impact demand for for example Emerging Markets bonds and equities.

For the keynesian-trained economist the story would end here. However, we cannot properly understand the impact of Chinese monetary policy on the rest of the world if we do not understand the importance of “local” monetary policy. Hence, in my view other countries of the world can decide to import monetary tightening from China, but they can certainly also decide not to import is monetary tightening. The PBoC might be a monetary superpower, but only because other central banks of the world allow it to be.

… China can act as a monetary superpower and determine monetary conditions in the rest of the world, but also that this is only because central banks in the rest of world … allow this to happen. Malaysia or Hong Kong do not have to import Chinese monetary conditions. Hence, the central bank can choose to offset any shock from Chinese monetary policy. This is basically a variation of the Sumner Critique. The central bank of Malaysia obviously is in full control of nominal GDP/aggregate demand in Malaysia. If the monetary contraction in China leads to a weakening of the ringgit monetary conditions in Malaysia will only tighten if the central bank of Malaysia tries to to fight it by tightening monetary conditions.

Update 1: The Turkish central bank did not listen to me and instead hiked interest rates very aggressively – trying to stabilize the lira, but likely also killing growth. Recession can no longer be ruled out in Turkey. See my day-job comment on the Turkish ultra aggressive rate hike here.

Update 2: David Beckworth has an excellent comment on Ambrose and me. Read it! After it was David who came up with the term monetary superpower.

Leave a comment


  1. Malaysian international reserves have barely budged in the past year; Bank Negara’s monetary policy committee is meeting today, and I expect no change in the policy rate.

    So far, they’re keeping to their commitment to a free float for the ringgit.

  2. TravisV

     /  January 29, 2014


    Could China’s aggressive easing-then-tightening of monetary policy explain gold’s dramatic rise (2009 to 2011) then fall (2012 to 2013)?

    Or has gold fallen because we’ve found so much new oil (increasing real interest rates and lowering the attractiveness of gold)?

  1. The sharply rising risk of Emerging Market policy blunders | The Market Monetarist
  2. The risk of Chinese monetary policy failure | The Market Monetarist

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