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China's interest-rate hike causes turmoil

The central bank's move is aimed at reining in an unbridled real estate market and inflation in China. The move sends stocks and commodity prices plunging around the globe and raises new concerns about the U.S. recovery.

October 19, 2010|By Don Lee and David Pierson, Los Angeles Times

Reporting from Washington and Beijing — A surprise interest-rate hike by China raised the prospect Tuesday that the world's economic locomotive will begin chugging at a slower speed — a move that battered stocks and commodity prices around the globe and raised fresh uncertainties over continued recovery in the U.S. and other developed nations.

The immediate aim of the action by China's central bank was to cool the nation's overheated real estate market and rising inflation. With more rate increases expected, it could slow the overall growth of the world's second-largest economy.

But any slowing in China could ripple abroad, creating new problems for already-struggling American businesses and workers. Much the same is likely in Europe and many other parts of the global economy.

Although the U.S. economy's troubles are much bigger than China's fiscal policies, Simon Johnson, an MIT professor and former chief economist at the International Monetary Fund, said the latest step by the People's Bank of China "doesn't address the core of these [economic] imbalances."

Friction has been increasing between the two nations over the widening trade deficit and allegations by some U.S. manufacturers that China manipulates its currency and unfairly subsidizes its exporters to maintain a price advantage.

"It certainly doesn't reduce the tension," Johnson said of Tuesday's rate hike. "I would suggest it's not helpful."

The effect will be felt most sharply in nearby Asian economies that have become increasingly dependent on the Middle Kingdom's markets and production base. But a decelerating Chinese economy may ultimately hit harder in the U.S. and other industrialized countries.

Their recovery from the Great Recession has been slower and many are still struggling with tepid growth, high unemployment and the threat of deflation, rather than inflation.

"We want China to consume more. The latest move would do the opposite," said Sung Won Sohn, an economist at Cal State Channel Islands. "Everyone wants to grow their economy through exports. But exports to China won't be as robust."

The Dow index dropped more than 200 points during the day largely on the news from China before closing down 165 points, or 1.5%, to 10,978.62. Prices fell for oil, copper, zinc and other commodities, while the dollar strengthened as investors sought the safety of the greenback.

The quarter-point rate increase will allow Chinese consumers to get bigger returns on their savings; the one-year deposit rate will go to 2.5% and benchmark lending rate to 5.56%.

For the Chinese, "this is a step in the right direction," said Michael Pettis, a professor at Peking University's Guanghua School of Management. "In the long term they should do more. But like the exchange rate, you can't change it too quickly or there will be financial distress."

While China has allowed the yuan to appreciate modestly in recent months, some analysts said Tuesday's interest rate hike may give Beijing reason to delay further strengthening because higher interest rates should help attract more capital inflows that could eventually boost the currency.

don.lee@latimes.com

david.pierson@latimes.com

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