The salvo from Washington as it unleashes the Green War with China leaves no doubt about the perilous state of Sino-US relations, and, incidentally, about Bidenomics. Yet, the remnant of a strong monetary link between the two countries brakes the journey into an intensified cold war between the two countries. Monetary realities mean the brewing cold war will likely occur in a more winding fashion than the headlines suggest.
Take as a key illustration the near 15-percent fall in the yuan’s real effective exchange rate since China’s real estate bubble finally burst in 2021-2. This is reassuring in one important sense. It tells us that the Chinese currency is playing to the same music of previous great crashes in once “star bubble economies.”
In all boom and bust sequences in the global economy as led by the Federal Reserve since the 1920s, the currency of the star bubble economy outside the US rises during the phase of powerful asset inflation, at least in real terms. That currency then comes under sharp downward pressure when the bubble turns to bust. Examples stretch as far back as far as the Reichsmark from 1924-33. They continue into the Great Fed Monetary Inflations of modern times.
The phase where the currency of the star bubble economy falls sharply is driven ultimately by the pattern of domestic spending. As this slumps in the wake of bubble-bursting, interest rates plummet whilst the central bank tries to press the monetary accelerator. Capital exports gain strength. This is in line with US interest rates and broader rates of return which are now diminished compared to perceptions during previous booms.
Such a constellation of forces in currency markets is evident behind the recent behavior of the Chinese yuan. Its depreciation acts to rebalance China into giant trade surplus and related strength of exports. There are grounds, however, for hypothesizing the playbook will become abnormally sinister on this occasion.
One avenue along the route for finding solutions is to distinguish active and passive elements in the process by which the economy became the star bubble economy. The distinction here relates to whether the intense bubble economy is spontaneously ignited wholly by perceived great advantages in its business sector. These, in turn, become the content of hot speculative narratives. Or, do political power bases in the bubble economy take advantage of the speculative financial climate to pursue policies (almost always related to vote-gaining) which enlarge the bubble in various ways? This is evident as far back as the rampant spending by cities and municipalities in the Weimar Republic.
The Federal Reserve’s monetary inflation drives the rise in speculative temperatures globally. There are degrees of freedom in the process, however, which depend on domestic politics or more broadly forces. Even so, the star bubble economy, which turns out to be at the epicenter of the global asset inflation, would never have formed without the solid catalyst of a very good and plausible economic story. We can see all of this in the case of the long-running Chinese bubble economy now going bust.
The Federal Reserve was already in an early phase of enabling the China bubble during the Great Greenspan monetary inflation of the mid-1990s to early/mid 2000s. At that point we could say the China bubble was not ostensibly out of line with some spectacular bubble economies elsewhere in the run-up to the Great Financial Crisis. That changed and China became the “star bubble of the global economy” under the “non-conventional” monetary policy of the Bernanke Federal Reserve (2008-12).
Then Beijing took full advantage of the Fed enabler (US money rates at near zero) to launch massive fiscal reflation (infrastructure and heavily real estate related) while fueling a global commodity boom. The fantastic real estate bubble in China stemmed from radical US monetary inflation.
Yes, there were strong good news stories related to the Chinese economy going beyond the politics of its real estate and infrastructure stimulation. These stories formed the base of powerful speculative narratives which helped spawn asset inflation in China. Particularly relevant here was the building of international supply chains—as spurred by the information technology revolution and the emergence of new regional or global trade integration blocs through the 1990s. There were evident advantages of these having an important Chinese component.
Could the Chinese authorities have sheltered their economy from the full throttle of US monetary inflation on this occasion as symptomized by violent asset inflation? Of course, but it suited them not to. In fact, they followed the opposite tack. They took advantage of US monetary conditions to pursue a range of political objectives which simultaneously transformed a giant bubble into a mega bubble.
And the same themes of active vs passive forces with respect to bubble formation (all in the context of an inflationary US monetary hegemon) continued into the Great Yellen monetary inflation of 2013-16/17. Yellen had kept rates down at zero, despite severe downward pressure on prices globally, fanning a global speculative boom of which China real estate was again an epicenter.
The First Powell Inflation which followed the Yellen inflation (with a brief interim pause through 2018 when the new Chair Powell made policy on the assumption that the Trump/Republican tax cuts would mean economic boom) added new impetus to the China bubble. This came when the Fed dramatically turned to stimulus amidst the US and global economic disappointments of late 2018 and early 2019 (which many commentators attributed to the US-China tariff war which had got under way). The Chinese authorities could have taken stronger action to contain the bubble—but they did not.
The bust came in the great pandemic, though this coincidence is far from proof of cause and effect. The pandemic unleashed one of the greatest monetary/asset inflations ever, the Fed-led great pandemic inflation supplemented by the Biden economics inflation. But that could not create a new bubble economy given the huge amount of interim bad news with respect to the Chinese economy and its geo-political position—most of all vis-à-vis the US.
The non-take off of a new bubble economy in China at this stage does not mean that depression and deflation are the essential on-going sequels—despite much media chatter about “Chinese deflation.” In fact, it is plausible that the lack of across-the-board price declines as the bubble economy has burst means that monetary conditions are still somewhat inflationary in China—with some speculative temperatures far from the real estate market still elevated in some instances.
Real depreciation coupled with competitive advantage in “new economy” sectors (for example, electrical vehicles and green industry more generally) are playing a role in economic re-balancing as in the cited examples of previous bubble bust under dollar hegemony. This time is different, many say, because of the extent of US political determination to prevent China taking advantage of US vulnerabilities—whether or not created by Bidenomics). Geo-political menace plays into this.
An autarkic outcome is dawning. Real depreciation and new competition will be the forces which Beijing channels into a range of exchange rate and trade policies/strategies with a wide range of non-US trade partners. These bilateral and sometimes multilateral deals will be a far cry from the general adjustment across the globe which has taken part in the past. But Beijing will not be always forcing the pace—quite the contrary. Immense costs associated with an acutely ageing society do not suggest that Beijing would be cavalier with the treasure of foreign assets—including those in the US—that are in the first channel of providing finance.