/Quick Point/ – China’s Interest Rate Hike Is Good for the US

Wednesday, October 20, 2010

China took a positive step yesterday that will benefit not only itself, but also all those countries engaged economically with it, including the US. Here’s why…

Sound reasoning

The Chinese government desires real, long-term growth. This goal means tamping down overly rapid expansion, price inflation and excessive speculation. In other words, China wants to pop any bubbles when they first form, before they can do real damage.

Their rationale is well laid out in the this China Daily newspaper article: “China raises key rates for 1st time since 2007” (By Wang Bo, October 20)

Steady policy

China’s action is in line with other recent ones taken for the same reasons – e.g., requiring higher bank reserves to reduce the inflationary and speculative effects of rapidly expanding bank lending.

Bonus: A lesson for other central banks

The world markets reacted “violently” for two reasons:

First, investors (and many central banks, including the Fed) are fixated on a single belief: Low interest rates are necessary for growth. Therefore, the Chinese rate increase must be bad for world economic growth. Economic history shows this belief to be erroneous.

Second, investors were “surprised” because the move hadn’t been discussed or signaled in advance. Actually, that’s how the Federal Reserve used to act. The reason? It takes less action if a central bank is secretive and mysterious. When everything is public, it takes a heavier hand to accomplish the same goal. And big moves risk reversing, rather than dampening, trends.

So… Do not fret about China’s latest move. It’s simply the latest, careful step to create long-term growth without the damaging effects of excess.

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October 2010