China held the Fed’s balance

The devaluation of the yuan appears to have influenced the decision to hold interest rates

The US Federal Reserve yet again postponed a hike in interest rates from near zero levels even after weeks of animated speculation about whether it was about time for the central bank to announce a ‘lift-off ’. In the past, Fed chief Janet Yellen and her colleagues on the Fed’s Open Market Committee were guided primarily by conditions in the US economy. This time around the developments in China, the world’s second-largest economy, appeared to have influenced the decision in favour of maintaining the status quo on low interest rates. Struggling to claw out of its worst slowdowns in more than a decade, China’s central bank has devalued the yuan to its lowest in nearly three years. The deepening economic crisis has sent ripples across the world.

The yuan’s devaluation in 1994, many analysts feel, led to the Asian currency crisis in 1997. Are we staring at a similar risk now? Given the considerable sway that China wields over the world’s economy, it is clear that such questions would have influenced the Fed’s decision. It is not common for a Fed chief to mention external economic conditions as the key variables that persuade major economic decisions. Ms Yellen was explicit in expressing unease over China’s wobbly economy. Her comments that “the question is whether or not there might be a risk of a more abrupt slowdown than most analysts expect,” need to be seen in this context.

Central banks across the world use monetary tools to stymie demand and cool prices. In times of weak growth and low prices, they keep rates artificially low to goad companies to invest, add capacities, hire, and prompt people to spend. When growth returns, they raise interest rates. Standard parameters do indicate budding recovery signs in the US economy. Its GDP has been expanding for several years now, a sign that recession is well and truly behind. Unemployment levels have fallen from a worrisome 10% to a more manageable 5.1%. Consumer spending seems to be on an upswing also, as can been seen from rising auto and home sales. There is a line of thought that given this backdrop, Ms Yellen may have missed an opportunity to turn on the interest rate cycle. Yet, the US Fed’s decision to hold interest rates demonstrates a subtle, but fundamental, change in its approach. It firmly reinforces the belief within the establishment that it is not the US but China and other emerging markets that are driving the global economy. Indeed, for the US, ‘decoupling’ from China and the rest of the emerging world is no longer an option. This may well mark the beginning of a new strand of thought in global economic policy making.