Commentary
After it joined the World Trade Organization in 2000 and anchored the Chinese yuan (a.k.a. renminbi) to the U.S. dollar, China linked its economy to the United States. Enforcing a fixed exchange rate regime with strict capital controls, China benefited from large inflows and relatively low-interest rates due largely to the low-interest rate environment in the United States. What happens to the Chinese economy when interest rates increase in the United States?
Sovereign currency policy faces the intractable dilemma of what economists call the “impossible trinity.” Countries can have a fixed exchange rate, free capital flow, or sovereign monetary policy but must choose only two of three. Economics textbooks give clean and clear definitions of each. Still, in reality, China tried to manipulate each and come out worse due to its attempts to manipulate the laws of economics….