Market volatility has its origin in two distinct sources, one is the change in Beijing’s exchange rate regime, another is the Federal Reserves unwinding. This will be messy.
Chinese leadership will not demonstrate the requisite fortitude so as to liberalize its capital, current account. Period.
Mull that one over for a minute.
The Chinese love institutionalized opacity. It has served their interests for decades, they’re going to find a way forward without liberalization. Why? The boys in Beijing cannot stomach operating like a first world economy. Transparency will not happen, because it isn’t useful to the regime.
China remains the world’s second largest economy and it has sought refuge in linking its nominal exchange rate and growth to the U.S. Dollar. Its entire Central Bank has enjoyed operating passively for decades. Now, with U.S. appreciation and the unwinding of our own mess, the Chinese have decided that inflation is the way to go. To Beijing, the link with the U.S. dollar must be less tenable, if only to partially threaten the Reserve status of the dollar.
Chinese technocrats are learning that nominal growth cannot be conjured.
Here’s the origin of China’s massive capital outflow: Chinese firms with high debt have an incentive to get out of yuan. The middle income trap is real and its sources lie in the indigenous social dynamics of Chinese political economy. Don’t worry, they’re not alone. Mexico, Russia, Indonesia and numerous other regimes have not navigated gradual overt changes out of authoritarian regimes.
The culture of Adam Smith’s invisible hand cannot be sutured on.