China keeps unprecedented influence on Fed and US monetary policy
Will the Federal Reserve begin to raise short-term interest rates in September given the devaluation of the Chinese yuan? What about October?
It seems less likely today that rates will go up in the early fall than this time last week -- and not just because of the economy or the latest labor reports. This time, it's because of China and the yuan.
The Fed has found all kinds of reasons for not raising rates this year. Now, with the possibility that the U.S. dollar will get stronger on its own, a Fed-driven rise in short-term rates would only add to the reasons for the value of the U.S. currency to rise. And, the Federal Reserve may not want this to happen.
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Now, however, the Chinese devalue their currency, the yuan, and the world seems to have shifted. Over the past three days, the value of the yuan (formally, the renminbi) has fallen by only 4.4% relative to the dollar, but all sorts of attention has been drawn to the event throughout the world.
Central banks, including the Federal Reserve System, are taking notice. The Chinese want this to be the case.
They want to become a big enough player in world financial markets so that others notice what they do. Europe would like to be able to garner this attention as well.
This is the whole reason behind the effort of the eurozone to create a strong political as well as currency union -- so that it can play at the highest levels in international markets.
Others would like to make it into the big leagues as well. This will change the whole dynamic of international financial markets and international policy making. The Federal Reserve will have to take notice of what the Japanese are doing with respect to the behavior of the yen.
The Federal Reserve will have to take notice of what the Bank of England is doing with respect to the British pound. And so on and so forth.
The world of foreign exchange is going to become interdependent in a way that it has not been for a long time.
The International Monetary Fund has cautiously welcomed the Chinese devaluation. In the mind of the IMF, the yuan has been too tightly controlled in the past and has allowed the Chinese to be accused of manipulating its currency, keeping the currency undervalued so as to support its export strategy.
The initial response of the IMF has been favorable because its leaders see the move by the Chinese as an effort to allow more market influence over the value of its currency.
In other words, the Chinese have gained more favor in the international financial community toward having the yuan accepted as another reserve currency in the world to sit beside the dollar, the Japanese yen, the euro, and the British pound.
The Chinese position is causing the Fed to pay attention to the value of the U.S. dollar in foreign exchange markets in a way no one else has in recent years.