China’s economic problems could be worse than Turkey’s - NY Times

While the world watches Turkey, the fate of the global economy depends on how China negotiates a weakening currency that is vulnerable to the U.S. dollar and capital flight, wrote the New York Times.

Many emerging markets make themselves vulnerable to financial crisis by spending more than they can afford, the article said, noting that Turkey was an extreme case even before President Recep Tayyip Erdoğan and his Justice and Development Party (AKP) took power in 2002. Turkish corporates currently hold $337 billion of foreign currency debt.

While the economic war against Turkey is a figment of Erdoğan’s conspiratorial imagination, the impact of a surging dollar, which has a long history of inflicting damage on developing nations, is very real, it said.

China is among the countries most vulnerable to the strong dollar for different reasons even though it is far less dependent on imports than Turkey, does not run a chronic trade deficit and does not have to borrow heavily in dollars to finance its purchases abroad, according to the New York Times.

China tried to keep its economy humming by ordering state banks to pump out new loans, the article said, with much more money circulating in China now than in the United States.

This money, it said, was in the hands of Chinese who are on the watch for higher returns and this is where China is faced with a serious risk of capital flight.

 The Fed’s tightening has further strengthened the dollar, the New York Times said, while Beijing’s easy money policies have further weakened the renminbi, which increases the incentive for Chinese investors to dump China’s currency for dollars.

Right now Chinese can earn the same interest rates in the United States for a lot less risk, so the motivation to flee is high, and will grow more intense as the Fed raises rates further.

Beijing could also diminish the allure of the strong dollar by trying to raise the value of its own currency. But that would mean tightening the supply of renminbi, which is likely to derail the economy at a time when growth in China is already slowing under the burden of too much debt.

China’s attempt to do away with the hegemony of the dollar by making the renminbi more widely popular, has so far been unsuccessful.

“More than 60 percent of the foreign currency held in reserve by central banks around the world is in dollars,” it pointed out.

Beijing has traditionally responded to signs of weakness in the economy by printing more renminbi, which worked at a time when United States was also running a very loose monetary policy. However, now that Washington is raising interest rates, lowering rates in China would open the door for investors to leave the country, the New York Times said.