Why the Fed is right to give China no wiggle room

By reaffirming its commitment to normalizing US interest rates, the Fed has sent a clear message to China on the eve of its first ever G20 summit: get your act together now, because we're not giving you more wiggle room for cheesy monetary stimulus, especially (but not limited to) devaluation.

This attempts to kill two birds with one stone: appeasing American populist political sentiment in an election year and forcing accelerated economic restructuring in China. Just as PBOC has become the standard bearer for China's continued opening to the global economy, so the Fed has become PBOC's crucial external enforcer of sorts. In such a way, Chimerica maximizes its chances of leading the global economy out of its low-growth funk.

To see why the Fed is helping China and not hurting it by adopting a hawkish tone, consider that the dollar has already gained nearly 3 percent against the yuan in 2016 - on top of 4.6 percent last year, when PBOC's surprise August devaluation sent global markets into a tailspin. This has taken enough air out of the yuan to prevent a hard landing, but with the onshore RMB barely 1,200 pips (12 yuan-cents) from its post-crisis low of 6.8 to the dollar in 2009-10, PBOC is right to draw a line in the sand: 6.8 is a reasonable floor to defend, as it's informally declared in the wake of Brexit. Any dip lower than that would represent an unmistakable regression for China back to export-driven growth aback a weak currency, which simply no longer suits its middle-income status and high-income, i.e. high-consumption, aspirations.

The Fed is thus preempting China by compelling Beijing to confront additional depreciation pressure on the yuan now rather than later. Now, not later, is the time to ram through capacity cuts and organizational and managerial restructuring of the bloated SOEs; now, not later, is the time to comprehensively begin to tackle the corporate debt overhang associated with these inefficiencies with the help of more efficient capital markets. If progress isn't being made or made fast enough, it'd better not be for complacency or inertia - it should instead be a natural reflection both of vested-interest resistance and of prudent caution in avoiding systemic socioeconomic instability.

Or to return to Fed-speak: we remain committed to normalizing rates as soon as feasible and are confident that the economy is robust enough to withstand it, even if we have to move far slower than the original timetable to give the markets and the emerging economies the windows of grace they need to adjust to the monetary normalization.

As China is very much a barometer for global risk sentiment and market confidence as a whole - a painful lesson for many market participants and observers last August and this January - the Fed's go-slow-but-firm strategy with regards to East Chimerica can also be taken as an overall go-slow-but-firm strategy with regards to the global economy as a whole.