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Interest Rate Hikes Likely to Lead to Global Slump
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By Shi Weigan
At the regular meeting of the Federal Open Market Committee (FOMC) which ended on June 29, the US Federal Reserve raised the federal funds rate by 25 basis points to 5.25 percent, the 17th interest rate rise in a row.

Unlike the statement issued after the May meeting, at which the federal funds rate was raised to 5 percent, after its June meeting, the FOMC did not say that "some further policy firming may yet be needed to address inflation risks." The omission was meant to be interpreted by the market as an indication that the possibility of further interest rate rises had been ruled out.

However, given repeated worries over inflation in the United States, openly expressed by Federal Reserve Chairman Ben Bernanke, a rate increase as mild as 25 basis points is unlikely to rein in inflation.

It is a common expectation that the interest rate will soon reach 5.75 percent to 6 percent.

Echoing the Fed, the European Central Bank increased its key interest rate to 2.75 percent on June 15. The Republic of Korea, Denmark and South Africa have also raised their interest rates by 25 basis points. And Japan's central bank may introduce its first interest rate rise in six years in July.

As a result, a global wave of interest rate rises will probably follow. Most countries may resort to tight monetary policies to combat intensifying inflationary pressure caused by global commodity price hikes, especially that of crude oil.

A worldwide tightening of monetary policies, though targeted against inflation, would serve to speed up a global economic slump.

Led by the price rises in copper, petroleum and gold, commodities have witnessed a global price surge since the beginning of this year.

By mid-June, the Reuters Commodity Index (CRB), one of the most widely used indicators of global commodity prices, stood around 370 points, its highest since 1980.

Crude oil prices remain above US$70 per barrel and the gold price is more than 20 percent higher than it was a year ago.

The long-time high prices of major commodities will certainly push up the prices of other products, making inflation almost inevitable. More importantly, such inflation would not be confined within the borders of one or several countries it would sweep the world.

The economic harm resulting from commodity price hikes is similar to what happened in the 1970s when the whole world was dragged into a depression by the soaring price of petroleum.

This time, the price hike involves metals used widely in industries, such as copper, lead, aluminium, zinc, precious metals like gold and silver as well as the agricultural produce. The inflationary pressures posed by all these hikes cannot be compared with those in the 1970s.

Therefore, even if a worldwide economic depression is not at hand, it is not far away.

Besides inflation, the world economy is also being burdened by several other factors: Economic engines that used to operate vibrantly have been fading away, the imbalance caused by the lopsided economic structure could not be corrected and several countries are in big trouble for trade deficits or fiscal deficits, or even both.

At the same time, one of the world's biggest economic powerhouses, the United States, saw its real estate bubble burst earlier this year.

The most important question to be answered is whether it is possible for the world economy to have a soft landing after so many countries apply the economic brakes.

European countries are seeing a resurgence of its industry and a strengthening consumer confidence, but the higher-than-normal level of its capital market will soon have a negative impact on its economy.

Admittedly, not every stock market slump is followed by a major depression. Yet in previous experiences, a new round of economic depression is always preceded by a stock market slump.

A dip in the stock market has been looming in many parts of the world since mid-May, including the United States, Europe, Japan and India.

In effect, the Fed's latest interest rate hike has underlined market expectations of further rate rises.

The drop in the stock market is probably a signal indicating the beginning of a new economic cycle in one or two years and a depression will certainly emerge soon.

The only good news is that the global economy has accumulated much stronger capability against the inflationary risks, which makes it able to resist the threats looming close.

The author is a PhD degree holder from the Institute of World Economics and Politics under Chinese Academy of Social Sciences.

(China Daily July 3, 2006)


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