For much of the year, investors have been fixated on when the Federal Reserve will achieve “liftoff” – that is, when it will raise interest rates by 25 basis points, or 0.25%, as a first step toward normalising monetary conditions. Markets have soared and plummeted in response to small changes in Fed statements perceived as affecting the likelihood that liftoff is imminent.
But, in seeking to gauge changes in US monetary conditions, investors have been looking in the wrong place. Since mid-August, when Chinese policymakers startled the markets by devaluing the renminbi by 2%, China’s official intervention in foreign exchange markets has continued, in order to prevent the currency from falling further. The Chinese authorities have been selling foreign securities, mainly US Treasury bonds, and buying up renminbi.
This is the opposite of what China did when the renminbi was strong. Back then, China bought US Treasury bonds to keep the currency from rising and eroding the competitiveness of Chinese exporters. As a result, it accumulated an astounding $4tn of foreign reserves.
And what was true of China was also true of other emerging-market countries receiving capital inflows. These countries’ foreign reserves, mainly held in US securities, topped $8tn at their peak last year.
The effects of these purchases attracted considerable attention. In 2005, US Federal Reserve chair Alan Greenspan pointed to the phenomenon as an explanation for his famous “conundrum”: interest rates on Treasury bonds were lower than market conditions appeared to warrant. His successor, Ben Bernanke, similarly pointed to purchases of US debt by foreign central banks and governments as a reason why American interest rates were so low.
