News analysis

If China catches a cold, the US gets a chill

China's rise now compels the Federal Reserve to look at external factors when setting policy

One cliche often bandied around as a truism in financial circles is: When the United States sneezes, the rest of the world catches a cold.

But if yesterday's statement by the Federal Open Market Committee (FOMC) is anything to go by, now the US is looking abroad when considering the health of its own economy.

Specifically, the US is concerned about the rise of China, recent signs the mainland is slowing sharply - and the coughs and sniffles that might afflict the US as a result.

The FOMC - the policymaking arm of the Federal Reserve - decided to keep rates at rock bottom for the 55th time in a row, a streak that began about nine years ago.

The move itself was not unanticipated - there was a 50 per cent chance that it would hike rates in September, according to economists polled by The Wall Street Journal. The statement itself talked about the same things as previous ones put out by the Federal Reserve - the labour market is improving, household and business investment spending has risen while inflation continues to run below targets.

  • PRESSURE ON RUPIAH

    It is a dilemma for us and also other countries. But if there’s no hike like this, pressures and speculation (on the rupiah) will continue. ’’

    DARMINNASUTION, Indonesia’s coordinating minister of economics, on the Fed delaying a raise in interest rates


    FEAR OF RAPID HIKES

    Alot of countries would face depreciation of their own currencies if the US raises rates rapidly just because of improvement sin its own economy, which would cause a reversal of capital backto the US. ’’

    JAPAN FINANCE MINISTER TARO ASO, on the worry of capital flight


    INDIA’S NEXT MOVE

    What we’ll have to do is continue doing what we are doing – which was anyway the intention regardless of the Fed decision. ’’

    RESERVE BANK OF INDIA GOVERNOR RAGHURAM RAJAN, on India’s monetary policy


    WATCH AND SEE

    We will watch market price action to see how the market is digesting the Fed move, check for impact of  portfolio flows on domestic liquidity and evaluate new inflation forecasts to see if there is need to finetune policy levers. ’’

    PHILIPPINES CENTRAL BANK GOVERNOR  AMANDO TETANGCO,on domestic monetary policy stance

All mostly run-of-the-mill stuff except for one line: "Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term."

For those who have been watching the Fed statements closely, this line was nothing less than a bombshell. Fed policy, which has almost focused exclusively on domestic concerns, was influenced by external factors, particularly emerging Asia and China.

China's decision to suddenly change its exchange rate regime on Aug 11 triggered the yuan's biggest depreciation in two decades and resulted in estimated losses of US$5 trillion in global markets.

The country's economy is slowing to a pace not seen in decades while exports continue to falter.

While this is not new - China's economy has been facing headwinds for the past six months - the fear now is that the world's No. 2 economy is heading for a hard landing.

Fed chair Janet Yellen later confirmed at a press conference that the line in question referred to China.

"We reviewed developments in all important areas of the world, but we're focused particularly on China and emerging markets," she said. In particular, she was worried about the pace of the slowdown.

It is easy to see why this has become the case. Size matters. The World Bank says China accounted for 13.3 per cent of global economic output last year, from less than 5 per cent a decade ago.

China also features prominently in emerging Asia, which has itself also been a major engine of growth for the global economy over the past few years.

Together, a slowdown in China could spark a recession in emerging Asia and that would have big impacts on US economic growth.

But given that it is unlikely that the same systemic risks are present in today's global economy, what this does mean is that the "bunker buster" move changes the way Fed decisions are taken from now on.

It means that the Fed recognises that if China's economy catches a cold, the US and the rest of us now will also get the chills.

A version of this article appeared in the print edition of The Straits Times on September 19, 2015, with the headline 'If China catches a cold, the US gets a chill '. Print Edition | Subscribe