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Yu Long/Color China Photo/AP

Balancing act

Money | China hikes a key interest rate in an effort to curb inflation and de-emphasize growth

Issue: "A second chance," Nov. 20, 2010

China's central bank-the world's top holder of foreign currency reserves-unexpectedly hiked a key lending rate by a quarter of a percentage point, touching off temporary havoc in world markets as investors worried that the rate increase could harm global growth. Stock markets tumbled and commodity prices, including for oil and gold, declined sharply.

The Chinese rate hike, aimed at tempering domestic inflation, came one day after the Communist Party Central Committee issued a draft of its latest five-year plan calling for "accelerating the transformation of the nation's economic-development pattern." Heritage Foundation analyst Derek Scissors, an expert on China's economy, told Barron's that the interest rate increase is part of the plan's strategy of "de-emphasizing growth and emphasizing better balance."

Later, China announced its economy grew 9.6 percent in the third quarter-slower than in the second quarter but still faster than any other economy in the world.

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Meanwhile, finance ministers from the G20 nations huddled in South Korea to talk about easing trade tensions and avoiding currency battles. They ended up with a vague, informal agreement in which industrialized and developing economies pledged to maintain trade balances at "sustainable levels" and to measure compliance by guidelines still to be negotiated. "Right now there is no established sense of what's fair," U.S. Treasury Secretary Timothy Geithner said before the gathering got underway.

Inflation ahead?

The Federal Reserve prepared to unveil a second round of "quantitative easing"-i.e., buying billions of dollars of Treasury securities in an effort to pump up the economy. The practice is akin to printing huge amounts of new money. Dissenting Fed member Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, characterized the policy as a "bargain with the devil," warning that it would likely stoke future inflation.

During its first round of quantitative easing that began in early 2009, the Fed bought a massive $1.75 trillion in Treasury securities and mortgage bonds. This time, purchases are expected to be on a lesser scale. Many investors seemed confident that at least some inflation is ahead, shown by their willingness to buy government notes with a negative interest rate.

At an Oct. 25 auction, the Treasury Department was able to sell TIPS (Treasury Inflation Protected Securities) that had a face value of $100 for $105.50-the first time such notes have been auctioned at a negative interest rate. The bond buyers will make money only if future inflation averages at least 1.5 percent a year for the next 4.5 years. Large institutions, including foreign central banks, bought about 40 percent of the $10 billion in negative TIPS.

Age approved

The French Parliament-withstanding weeks of street protests and union strikes that sparked travel chaos, school closings, and fuel shortages (see "Riots against reality," Nov. 6)-approved a landmark pension reform bill. The legislation raises the threshold age for a minimum pension from 60 to 62 and the age for a full pension from 65 to 67. President Nicolas Sarkozy is expected to sign the bill in mid-November.

Joseph Slife is the assistant editor of SoundMindInvesting.com.

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