You don’t hear much these days about capital outflows from China. The renminbi seems well behaved, and China’s foreign exchange reserves have stayed stable in the past couple of months. Sure, the economy itself faces a bunch of challenges, as the government hasn’t quite found a way to maintain rapid growth rates without a dangerous degree of reliance on credit. But you don’t get the sense that the Chinese are falling over themselves in a rush to buy dollars.

The Fed might take heart from this. On two occasions in the past year, the US Federal Reserve’s intentions to raise interest rates have been confounded by financial turbulence caused by large outflows from China. The first was last summer, when the Fed was forced to postpone rate hikes following a surge in flows from China after the People’s Bank of China (PBoC) introduced a new regime for fixing the renminbi on August 11th. The second was this winter, when another surge in outflows that coincided with the Fed’s December rate hike made it impossible for the Fed to keep doing so. So, if capital seems happy to stay in China, is it now ‘safe’ for the Fed to tighten US monetary policy?

Not quite. Actually, the main reason why capital isn’t flowing from China these days is precisely because of the fact that the Fed hasn’t been expected to raise rates. If that were to change, capital outflows from China would once again become a source of global risk aversion.

US monetary policy and the capital account of China’s balance of payments are joined at the hip. To understand why, it is important to look back to the period 2009-2013, when many emerging economies took advantage of very loose US monetary policy and borrowed heavily in dollars. Borrowers in Brazil, Russia, India, Indonesia, Mexico and Turkey all responded to the Fed’s Quantitative Easing by adding relatively cheap dollar liabilities to their balance sheets.

But the way China borrowed dollars during this period was quite different to the others. While most countries issued dollar bonds with relatively long maturities to institutional investors, the bulk of the dollars that China borrowed during this period came from international banks with rather short maturities.

At the end of 2008, China’s external debt to foreign banks was less than $200bn, according to the Bank for International Settlements (BIS) (which almost certainly understates the scale of this borrowing). By early 2014, that stock had risen to over $1tn. Astonishingly, a full 80 per cent of this debt carried original maturities of less than one year. No other emerging economy borrowed so much at such short maturities from banks. To do so would have been a ‘rookie error’: most of these countries knew from their own painful financial histories that sensible borrowing is done by issuing long-dated debt.

The reason why the Chinese borrowed so many dollars with such short maturities lies in the attractiveness of the ‘carry trade’: Chinese banks and firms could borrow dollars very cheaply, sell them for renminbi and then buy a Wealth Management Product (a deposit-like instrument) yielding, say, 6 per cent. And for most of this period, the renminbi was also appreciating predictably against the dollar. So they were profiting not just from the China-US interest rate differential, but also from the capital gain delivered by ‘shorting’ a weakening dollar.

The accumulation of short-term dollar debt by Chinese borrowers created a feedback loop between US monetary policy and China’s capital account, in the following way.

Step one: the Fed is expected to raise rates (or, as in December, actually does). Step two: capital is sucked from China, because tighter US monetary policy both strengthens the dollar and cuts the China-US interest differential, giving Chinese borrowers good reasons to unwind their short-dollar positions. Step three: the ensuing capital outflows from China fuel global risk aversion, adding volatility to international capital markets. Step four: that volatility makes it too dangerous for the Fed to tighten policy.

A circuit-breaker is at work, then: the Fed’s ability to raise rates is hobbled by the market volatility which is created by the impact that US monetary tightening has on capital flows from China.

Over time, this feedback loop is likely to lose its force, and China’s capital account might stop being a burden on the Fed. But we’re not there yet. At the end of last year, the cross-border debt that China owed to international banks was still over $750bn, according to BIS data.

That means the Fed still has a ‘China problem’: any effort it makes to tighten policy will, once more, activate the feedback loop and suck capital from China with what are now predictable consequences. And since net capital outflows are generally unsupportive of growth, the underlying economic problem that China faces can only be made worse by US monetary tightening.