The only real significance of China`s decision to raise interest rates slightly on its one-year benchmark lending rate and deposit rate is that it is following the Fed`s lead in trying to forestall inflation and that it will not work. Today, for the first time in nine years, since the People`s Bank of China officially pegged the yuan to the dollar at 8.2 to the dollar, it raised its administered one-year rate by 0.27 percentage points to 5.58%, and the amount state banks pay on deposits by the same percentage amount, to 2.25%. This comes after its attempt to "cool off" China`s rapidly growing economy with credit controls on selected industries failed to have any significant effect on consumer and producer prices.
Why should it? By pegging the yuan to the dollar, China imports the Federal Reserve`s monetary inflation right down to the penny. When the dollar/gold price was at its optimum rate of $350 oz in 2002, the yuan/gold rate was Y2870. Today, with gold at $425, it takes 3485 yuan to buy an ounce of gold. If you recall, China was said to be considering a revaluation of the yuan early this year, when gold hit $430. Because China`s debt structure is not as mature as ours and because it is still mostly a commodity-based economy, other yuan prices move more quickly in China than they do here. When the U.S. showed its first signs of real strength in March and the dollar/gold price declined to as low as $380 oz, the pressure was off China to do anything. Now the pressure is back, but instead of immediately doing anything about its dollar peg, it is trying the interest-rate maneuver, which will do nothing to hold back the monetary inflation -- just as the Fed`s attempts to hold back inflation with a higher funds rate is bound to fail.
What to expect? If the PBC continues to follow the Fed`s lead, it will go through another few quarter-point rate hikes. The only real effect will be to slow the rate of growth of the economy as credit tightens at the margin. The immediate reaction in the world commodity market has been to mark down the industrial metals on the expectation that China will also slow its imports of these. Oil came off too on the same supposition. A lower dollar/oil price of $51 instead of $55 and climbing is of course a bit of good news for the U.S. economy, increasing the demand for liquidity and taking a few dollars off the gold price -- here and in China. Globalization in a world of floating currencies keeps the markets on their toes.
If the markets see good news coming out of next Tuesday`s presidential elections, especially bearing on conditions in the Middle East, I expect oil will drift below $50 bbl. I expect Senator Kerry will win. Pollster John Zogby told me late yesterday that`s what he now sees, with momentum continuing to shift toward the Democrat and away from President Bush. I do think Kerry will be an improvement in this regard, and yesterday I posted my decision to vote for him Tuesday -- while voting Republican for the rest of the ballot. I plan to have a more detailed exposition of how I see a Kerry presidency for institutional clients on Monday.