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Stocks dive amid renewed global concerns

Inflation-control measures in China and debt woes in Europe fuel fresh instability.

November 17, 2010|By Tom Petruno and Nathaniel Popper, Los Angeles Times

Reporting from Los Angeles and New York — When financial markets crumbled two years ago, triggering the deep global recession, investors looked to governments and central banks to restore confidence.

Now, as the world economy rebounds, policymakers are at odds over how best to keep the recovery going — and their disagreements are fueling fresh instability in markets.

Investors' concerns boiled over Tuesday, driving stocks sharply lower worldwide. The Dow Jones industrial average slumped 178.47 points, or 1.6%, to 11,023.50, the biggest one-day drop since mid-August.

"There is a lot of risk out there, and a policy mistake is the primary one," said Tom Higgins, a global strategist at money manager Standish in Boston.

In China, the Shanghai stock market tumbled 4% after the government signaled that it was considering price controls to rein in inflation, which has hit two-year highs. The news also triggered another dive in commodity prices on fears that China's voracious appetite for raw materials would be curbed by moves to slow economic growth.

Steep declines in cotton, copper, wheat and corn drove the Reuters/Jefferies CRB index of 19 commodities down 3.2% for the day and left it down 7.2% from its two-year high reached last week.

"People get very nervous anytime you try to cool off an economy," said Anthony Chan, chief economist at JPMorgan's private bank. "You are dealing with blunt tools and there is always the risk that you overdo it."

In Europe, where stronger economic growth would be welcomed, stocks fell sharply as the continent's government-debt crisis deepened again.

Ireland, saddled with crushing costs for bailing out its banks, faced pressure from the rest of the European Union to tap an EU assistance fund rather than risk more damage to the country's finances.

EU officials also fear a "contagion" effect that could cripple other struggling economies, particularly those of Portugal and Spain.

But the Irish government was resisting, reluctant to embrace new controls on its economy that would come with formal EU help.

In the U.S., anger intensified in Congress over the Federal Reserve's plan to pump an additional $600 billion into the financial system, a move critics said was unnecessary and risked fueling an inflationary surge.

Rep. Mike Pence (R-Ind.), an influential member of the new GOP majority in the House, introduced a bill to change the Fed's mandate. The legislation would force the central bank to focus solely on keeping inflation under control, removing the second mandate of promoting high employment.

That essentially allies the GOP with the Chinese government and other major U.S. trading partners that have complained that the Fed's easy-money policy has helped inflate global bubbles in commodities and other assets while devaluing the dollar.

Although the future of Pence's bill is uncertain, it is another sign that the Fed, which is supposed to be independent, now finds itself embroiled in partisan politics.

"If the Fed loses its independence and becomes politicized, it's a negative" for investors, said Doug Kass, a general partner at investment firm Seabreeze Partners in Palm Beach, Fla.

In part, the upheaval in markets in recent days has been a reaction to the lack of consensus at the meeting of the 20 leading industrialized nations last week in South Korea. The G-20 leaders couldn't agree on a common path for sustaining the recovery, which leaves markets fearful of more policy clashes that could undermine global growth.

"There is an overall feeling that governments are failing globally to completely grasp what is happening and how to address it," said Andrew Busch, a public policy strategist at BMO Capital Markets in Chicago.

Unlike two years ago, when the world economy was in a free fall, governments and central banks find themselves at different phases of recovery.

Much of Asia has been growing rapidly again and is facing rising inflation. That has spurred central banks in the region to tighten credit. The latest: South Korea's central bank on Tuesday raised its key interest rate to 2.5% from 2.25%.

The European Central Bank hasn't raised rates but has vowed to pull back on special lending programs it began providing to European banks during the recession. Despite Ireland's woes, ECB board member Juergen Stark said in a speech Tuesday that the bank would continue its "exit" strategy from those lending programs early in 2011.

The Federal Reserve has taken the opposite tack. Under the Fed's so-called quantitative easing plan, announced Nov. 3, the central bank committed to buying $600 billion of Treasury bonds by mid-2011, an attempt to hold down longer-term interest rates such as those on mortgages.

Fed Chairman Ben S. Bernanke has argued that the move was justified by still sky-high U.S. unemployment.

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