Investors are used to worrying about geopolitical tensions. Those haven’t gone away, but the greater threat to markets these days is probably geo-financial: the dire global effects of financial decisions which serve the national economic interest. China, which plans to sit at the centre of any new world economic order, is a good place to start. In their pursuit of growth, the Chinese authorities cut an important monetary corner. They did not let the exchange rate rise much along with prosperity.
The artificially cheap renminbi, the local currency, has kept millions of low-skilled workers in jobs. But it has created a monetary mess around the world. The resulting trade surplus first helped fund global asset price inflation.
Now it is providing the money to push inflation up in China, besides drawing in funds from foreigners betting that currency will eventually have to rise enough to cut down the trade surplus. On Wednesday, the government announced draconian restrictions on exporters trying to change foreign currency into renminbi. The combination of domestic inflation and a rising currency means the prices for goods imported from China will rise. The industrial workshop of the world is exporting inflation along with shirts and microwaves.
Across the Pacific, the US continues with its policy of monetary isolationism. The Federal Reserve has tried to keep the economy strong through low interest rates, all but ignoring the value of the currency. So the US, which still needs to finance a big deficit, offers negative real interest rates on its government debt. The result is bad for the world. Currencies that float freely are rising against the greenback. That makes life hard for the European Central Bank, which increased the overnight interest rate by 25 basis points (or a quarter of a percentage point) on Thursday. Fear of an overvalued euro may keep it from doing more. Currencies that are tied to the dollar are in the midst of an inflationary crisis. And losses mount for US creditors.
National monetary authorities may think they should look only to the national interest. But in an interconnected global economy, the result of too many narrow perspectives is a set of monetary worlds in collision.