'The Real Reason to Worry About China'

Narayana Kocherlakota:

The Real Reason to Worry About China: The world's largest currency union contains about 1.7 billion people and accounts for more than a third of global economic output. It also may be headed for a breakup...

I’m talking, of course, about the U.S. and China. For more than 20 years, China has kept the yuan's value against the dollar in a very tight range. ... 

Over the past couple decades, China has been able to offset the effects of Fed policy by varying its relatively large level of public investment. It has always been clear, though, that China would no longer want to use fiscal policy in this way once its economy was sufficiently developed. The country's currency moves over the past few months suggest that it might have reached this point. ...

Any such breakup presents a big problem: Many businesses and financial institutions have entered into contracts that make sense only under the premise that the exchange rate is not going to vary much over time....

As far as I can tell, U.S. economic policymakers aren’t putting much emphasis on the potential repercussions of a break-up of the China-US currency union. ... There's a significant risk that if the Fed keeps tightening in 2016, it could force an abrupt break-up. The resultant disorder in the world economy would not serve Americans well.