Must-Read: Gavyn Davies: China’s Policy Failings Challenge the Fed

Must-Read: I cannot help but note strong divergence between the near-consensus views of Fed Chair Janet’s and Fed Vice-Chair Stan’s still-academic colleagues and students that tightening now is grossly premature, financial markets’ agreement with the hippies as evidenced by the ten-year breakeven, commercial-banker and wingnut demands for immediate tightening, the extraordinarily awful performance since 2007 of not all but the average regional Fed president as revealed in the transcripts, and the Federal Reserve’s strong predisposition to an interest-rate liftoff soon. That divergence plus the apparent focus of what is a global hegemon on its domestic situation make me think that this is not a well-functioning institution we have here:

Gavyn Davies: China’s Policy Failings Challenge the Fed: “There is something… important… doubts about the competence and credibility of Chinese economic policy…

…and the appropriateness of the US Federal Reserve’s monetary strategy…. While overall Chinese activity was not disastrous, the sectors of the economy that were most important for commodities–real estate, construction and manufacturing–were clearly weaker than the expanding services sectors. China pessimists… claimed that the “inevitable” Chinese hard landing was at hand…. Martin Wolf and David Pilling have rightly suggested in the FT that China’s economic problems are deep seated, stemming from an unbalanced economy that is far too dependent on investment, and on inherent contradictions between the need to introduce market forces in the long term, and the need to retain state control to deflate the leverage bubble in the short term. Perhaps the regime of President Xi Jinping and Premier Li Keqiang needed to be super-human to navigate all this. But the policy errors of mid 2015 suggested instead that they were split, indecisive and confused….

Shorn of any reassurance from a credible economic framework in China, western investors have turned their attention to their ultimate security blanket, the Federal Reserve. But the Fed seemed to have embarked on a pre-determined course to raise US interest rates before year end…. But as Lawrence Summers argued this week:

A reasonable assessment of current conditions suggests that raising rates in the near future would be a serious error that would threaten all three of… price stability, full employment and financial stability….

Financial markets… act… as if they are experiencing an adverse monetary policy shock from the Fed… rather similar to… 2013…. Markets have refused to believe that the Fed would raise interest rates as early, or as fast, as the Federal Open Market Committee has shown in its “dots”…. [recently] increased their belief that a rise in US rates would be inappropriate this year. Yet… the Fed has shown little sign of wobble…. Some investors are beginning to agree with Mr Summers that another dose of quantitative easing may be necessary…. The Fed’s… path for tighter policy is no longer consistent with stable financial markets. Something will have to give.

August 28, 2015

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