Fisher Investments Editorial Staff
Currencies

The Great Monetary Wall

By, 10/20/2010

Story Highlights:

 

  • Markets fell on China's unexpected interest rate hike Tuesday.
  • Investors worry China may go too far, choke growth, and imperil the global recovery.
  • The risk of a monetary mistake is ever present, but we haven't seen anything too egregious yet.   

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China's unexpected interest rate hike Tuesday—the first since 2007—took global markets by surprise, knocking the MSCI World back -1.6%. The market reaction can partly be explained by surprise factor—virtually nobody expected a hike, and markets revile sudden revelations. But more broadly, investors worry China may go too far, choke growth, and imperil the global recovery. (Mind you, paradoxically, the opposite worry is out there too—that the government may not go far enough.)

 

Given a few days to mull things over, investors may remember China has tightened policy all year without choking growth—raising rates isn't the only tool for monetary tightening. The government has raised reserve requirements four times, placed limits on mortgages, and returned the yuan to slow appreciation to the US dollar—yet Q2 GDP surged 10.3% y/y. Fast expansion and pockets of inflation (notably in housing) necessitate some dismantling of 2008-2009's great monetary wall. And investors would surely likewise worry if China were to take no action at all.

 

Of course, too much tightening would be problematic. And there are some signs China is painfully aware of that fact. As officials have tightened via interest rates, the yuan, and reserve requirements—they also appear to be balancing the equation by loosening bank lending quotas. Bank lending represents roughly 80% of funding in China and is a formidable monetary tool. Lending exceeded expectations in September (596 billion yuan vs. an expected 500 billion yuan) and is on track to surpass its 7.5 trillion yuan annual 2010 quota.

 

All this isn't to say China will get it just right. The risk of a monetary mistake is ever present. But we haven't seen anything too egregious yet. And there's some precedent for current policy. China followed a similar course from 2005-2007—even as the economy grew and inflation remained largely in check.  

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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