Fed Creates‘Interest’in China

The era of free-flowing and cheap money is ending， as the United StatesFederal Reserve （Fed） raises its benchmark interest rates from rock bottom for the first time in years.

At a press conference following the announcement of the rate hike， Fed Chairwoman Janet Yellen said that even after this increase， the stance of monetary policy remains “accommodative.” That is to say， the rates are still low—the hike should not endanger the stability of the global economy. This action “recognizes the considerable progress that has been made toward restoring jobs， raising incomes and easing the economic hardships of millions of Americans.” Yellen added that the process of normalizing interest rates is likely to proceed gradually.

The biggest reason why the Fed has chosen to act recently may be that there is no reason for not raising interest rates， and that the increase is moderate.

However， what the market is most concerned about is not the slight boost in rates. The big news to look forward to will be the Feds planned increments to the interest rate in 2016. The UBS Group AG and some other institutions expect the Fed to raise the interest rate by about 100 basis points throughout three or four times during 2016.

The interest rate hike marks the beginning of the Yellen era. To China and other emerging markets， the normalizing of the interest rate by the Fed will bring huge impacts.

The move by the Fed also indicates that while emerging economies are likely to get into or remain in recessions， the U.S. economy has ultimately recovered. Moreover， the first rate hike in almost a decade also signals a historic change in U.S. monetary policy. Their withdrawal of quantitative eas- ing （QE） produces two results： The U.S. dollar becomes stronger and other currencies depreciate； more dollars are flowing back to the United States and international capital is flowing out of emerging markets.

The impact of the Feds policy changes on emerging economies is evident. When the United States was printing money to address the crisis， these economies became a reservoir for the excessive liquidity. The cheap capital therefore created unsustainable growth and expanding asset price bubbles in emerging markets. As a result of the huge inflow， emerging markets had to raise their leverage. Therefore， emerging markets had to address the impact from external market through increases in liquidity and borrowing. As leverage rose， local government debt and financial systematic risks grew in tandem due to a thirst for investment stimulated by capital inflows.

Now that the Fed has withdrawn its policy of QE and the U.S. dollar is becoming stronger， international capital is flowing out of emerging markets. Since 2013， the turmoil caused by a huge level of capital outflow from emerging markets was actually a result of the U.S. monetary policy changes.

An interest rate hike by the Fed doesnt mean that risks will disappear. The Chinese economy， which is seeing a slowdown in growth， will face more challenges： The pressure of stabilizing the yuan has intensified， and the government must now pay full attention to the control of capital outflow.

Because of the previous high leverage and credit expansion， new risks in the Chinese economy are being unveiled now. The Feds latest move just worsens the condition of Chinas economy.

In the future， China must take the initiative in addressing the impacts of an increasingly normalized U.S. monetary policy.

China should maintain an accommodative money policy throughout 2016， and the cuts to the reserve requirement ratio must be carried out resolutely.

China must face up to the risks of the yuans exchange rate. The future trend of its exchange rate depends on the strength of the Chinese economy. Under the circumstances that the U.S. dollar becomes stronger and the yuan is being overvalued， China should never squander the foreign exchange reserves it has in order to maintain its currencys exchange rate. This is because a stronger yuan never means that its exchange rate must be kept high.

In addition， the Chinese Government should pay more attention to corporate debt risks and shut down “zombie” companies. It must also ensure the stability of the real estate market. Finally， China should continue improving its financial soft power to a strategic level， in order to prevent potential international financial risks from being transmitted to China.

The interest rate hike by the Fed will surely affect the Chinese economy， but it is merely an external factor， which will not undermine Chinas growth.

The foundation for the countrys continued economic growth lies in that China adheres to reforms and economic restructuring while simultaneously enhancing the growth that is being driven by mass entrepreneurship and innovation.