Beijing and Washington take opposing positions to try to avoid the economic crisis

Xi Jinping and Joe Biden both face major political events in the final months of this year and want economic conditions to be as favorable as possible, but the two have taken opposing approaches on the desirable course of interest rates. interest.

For the US president, who faces an election in November that could break the Democrats’ already fragile grip on Congress, the biggest risk is rising prices for essential consumer goods. As a result, Biden sees the case for higher interest rates.

“The critical task of ensuring that high prices don’t take root falls on the Federal Reserve,” Biden said at his first press conference of the year.

“Given the strength of our economy and recent price increases, it is appropriate, as the Fed Chairman [Jerome] Powell indicated, to recalibrate the support that is now needed,” he said.

Xi must smooth the way at the National People’s Congress, to be held in October or November, which is expected to endorse his leadership for an unprecedented third five-year term.

He wants the Fed and European Central Bank to continue the accommodative monetary policy that boosted the global economy during the Covid-19 pandemic.

“If major economies slow down or reverse course in their monetary policies, there would be serious negative fallout. They would present challenges to global economic and financial stability, and developing countries would bear the brunt,” Xi said. during the Davos conference in a video address on January 17.

Markets are pushing the Fed to start raising rates in March, with some economists calling for a 0.5% hike to show the central bank’s determination to control inflation.

If the US concern is that its economy is overheating under the pressure of strong consumer demand and supply chain constraints, China’s concern is the opposite. Chinese authorities fear that consumer demand is already too weak and vulnerable to both further slowdowns in the struggling real estate sector and the effects of further Covid shutdowns.

While China’s fourth-quarter GDP figures appeared to show a healthy recovery from depressed 2020 results, growth was mainly driven by exports, which rose 30% on the year. Retail sales in December were just 1.7% higher than a year earlier, while sales in 2021 were up just 3.9% from pre-Covid levels in 2019 .

China relies on demand from the West, primarily the United States, to sustain its growth, rather than spending by its own massive population.

The World Bank’s latest global outlook review highlighted the risk that China’s housing crisis could trigger financial turmoil that would ripple through much of the developing world. The bank highlights the heavy debts carried by Chinese property developers.

“The risks and potential contagion costs of heavy corporate deleveraging, particularly in the real estate sector – with combined onshore and offshore liabilities amounting to almost 30% of GDP and strong ties to various parts of economy – far outweigh any potential damage caused by the collapse of a typical large industrial enterprise,” he said.

The review notes that corporate bonds issued by Chinese property developers are already trading at distressed prices, indicating that financial markets are expecting widespread defaults.

The real estate sector represents about a quarter of Chinese investment, is an important source of income for local authorities and households, and is the destination of 40 to 50% of bank loans.

The Chinese authorities are reacting to the risks linked to the economic outlook in a classic way. The State Council has announced its intention to increase the size of the high-speed rail network from 38,000 to 50,000 kilometers by 2025, with a commitment to focus on construction which could begin this year. The central bank has reduced reserve requirements for banks, while state-owned enterprises are being asked to take over the completion of struggling private sector property developments.

But the government has yet to ease tougher borrowing guidelines for property developers that have pushed China’s second-largest, Evergrande, into a financial crisis that is spreading through the country’s property sector.

In his Davos speech, Xi defended the “common prosperity” strategy that has been used to justify regulatory crackdowns on a range of private sector industries, saying it was aimed at ensuring that “everyone will get a fair share of development and that development gains will accrue to all”. our people in a more substantial and fair way”.

The danger for China and for Xi is that the preponderant role of the state fails to tame an ongoing debt crisis that has its own circular logic, with loss of confidence in property developers leading to falling real estate prices which further weakens the security of their already tenuous debts.

The continued efforts of the Chinese authorities to achieve zero Covid is an additional risk to the country’s economic performance this year. The success so far in suppressing Covid has been hailed by Xi as evidence of the superiority of China’s form of government, but it hasn’t come free, with harsh lockdowns imposed wherever cases occur. The virulence of the Omicron strain of the virus tests the durability of the strategy.

Xi has reason to see rising US interest rates as a threat to the global economy and to developing countries in particular. Higher US rates would cause a tidal movement of capital out of the rest of the world into the United States. Developing countries whose currency is pegged to the US dollar would have no choice but to raise their own interest rates, regardless of their domestic circumstances. Rolling over US dollar debt would become difficult, increasing the risk of defaults.

Even China, which apparently manages capital flows in and out of the country, would face pressure to devalue its currency, increasing the local burden of its US dollar debt.

It all depends on how far the Fed will go. While there is consensus that the United States no longer needs the 0% rate stimulus and massive central bank purchases of government bonds, many still argue that inflation high (7% on the year to December) is the result of supply chain issues rather than excess demand. This means that interest rate hikes would have little effect.

The nightmarish outcome for Biden would be an interest rate hike and price increase. Around the world, excessively restrictive monetary policy is a known cause of recession – the Australian recessions of 1990 and 1982 come to mind. Biden and Xi both hope that this scenario does not happen.

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