Raising interest rates too quickly could reverse the slow recovery under way in the world’s economies, warns World Bank President Robert Zoellick.
"Waiting for bubbles to burst and then cleaning up the aftermath is now a new lesson of what not to do," Zoellick wrote in an article in the Financial Times.
"But tightening interest rates too abruptly — especially where recoveries are weak, such as in the U.S. and Europe — could trigger another downturn."
Australia has already raised rates, which could lead its Asian trading partners to follow suit, Zoellick wrote. Yet the Fed has stayed at virtually zero and its members have promised to keep rates low for a lengthy period.
"Raising rates while the Fed keeps its rates close to zero would cause Asian currencies to appreciate. This would make their exports more expensive and decrease overseas sales, hurting recoveries based on exports."
In Fed minutes released Tuesday, members seemed increasingly concerned that the low U.S. interest rate is sparking global speculation, the kind of dollar “carry trade” many top economists now warn is creating bubbles in assets as varied as Hong Kong apartments, precious metals like gold, and Chinese stocks.
“Members noted the possibility that some negative side effects might result from the maintenance of very low short-term interest rates," the central bank reported in the minutes.
Meanwhile, the investment guru who runs the world’s biggest bond fund at Pimco, Bill Gross, says a speculative bubble is, in fact, emerging in China. China’s major bank regulator this week advised banks to shore up cash after a massive, government-directed lending spree to offset the recession there.
Real economic growth there is still constrained by limited consumer demand from the United States and other trading partners
Gross told Bloomberg News that the Chinese will have “a bubble of their own” to confront shortly.
“It’s gearing up for export that doesn’t find an end consumer, that’s the real problem in China.”
Constrained growth potential in the United States will be the “new normal” for a while, Gross contends.
“With U.S. unemployment in the double digits and likely to stay close to that for the next six months despite job creation ahead, the Fed has nowhere to go,” Gross says.
China’s trade surplus with the United States nearly doubled in October from the previous month to $24 billion, figures from the Customs Bureau show.
The Shanghai Composite Index of shares has returned 84 percent so far this year. The index is valued at 35 times reported earnings, more than doubling in a year.
This is unsustainable, notes Gross.
The “systemic risk” of another asset bubble is rising, in part because the Federal Reserve has kept interest rates at record lows.
What’s more, there are other, potentially difficult developments.
“China may abandon its dollar peg within six months’ time and with it, its own easy monetary policy that has fostered more significant mini-bubbles of lending and asset appreciation on the Chinese mainland,” Gross adds.
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