Macroscope | Fed policy could create belt and road debt default headache for China
- The US central bank will do whatever it takes to curb inflation, including cutting the supply of US dollars and raising borrowing costs, leaving emerging economies struggling to buy dollar-denominated goods
- Even China, seemingly protected by its huge reserves of US dollars, is at risk as a major lender to smaller economies
With US consumer price inflation currently above 8 per cent, way above its 2 per cent target, the Federal Reserve is going to do whatever it has to do to remedy that situation and, let’s not be under any misapprehensions, the Fed sets monetary policy only with the interests of the US economy in mind. If that is a problem for other countries, c’est la vie.
In 1994, the Federal Reserve embarked on a sequence of US rate hikes that helped precipitate the Mexican peso crisis.
In the second half of that year, growing market nervousness about the sustainability of Mexico’s domestic fiscal and monetary policies, allied with rising yields on US Treasuries, prompted massive capital outflows out of the Mexican peso and into the US dollar that put the peso’s then-pegged value to the greenback under enormous strain.
Unable to hold the line, Mexico moved the peg on December 20, 1994, devaluing the peso versus the greenback, only to find that the pressure on the Mexican currency did not dissipate. Throwing in the towel, the Mexican authorities opted for a full float and further devaluation before the end of that year. A full-scale Mexican sovereign debt default looked a real possibility.