The global economy cannot afford higher US interest rates

Article Highlights

  • The back-up in US long-term interest rates (1.6% to 2.9%) is damping the US housing and durable goods markets.

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  • We see the damage that higher US interest rates have wrought on the emerging market economies.

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  • Rising long-term US interest rates would risk reigniting the euro crisis by raising questions about debt sustainability.

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Sir, David Rosenberg’s bold call that we are at the start of a secular bear market for US long-term bonds would seem to be questionable for both domestic and more importantly for international reasons (“Don’t bet against Bernanke’s quest for higher inflation”, Insight, September 10).

The back-up in US long-term interest rates from 1.6 per cent in May to about 2.9 per cent at present already seems to be damping the US housing and durable goods markets, which have been primary contributors to the still feeble US economic recovery. One would think that a further significant back-up in US long-term interest rates would run the real risk of preventing the US economy from recovering at a pace that would reduce the large gaps that still characterize the labor market. That in turn would keep US inflation well below the Federal Reserve’s desired rate.

At an international level, we have already seen the severe damage that higher US long-term interest rates have wrought on the emerging market economies, the main source to date of global economic growth, as capital has been repatriated from those countries to the US. Major emerging market economies including Brazil, India, Indonesia, South Africa, and Turkey are all now in the grips of acute currency weakening that would only intensify were we to get further increases in US long-term interest rates.

Rising long-term US interest rates would also risk reigniting the euro crisis by again raising questions about debt sustainability. This would seem to be particularly the case when one considers that countries such as Ireland, Italy and Portugal all have public debt to gross domestic product ratios in excess of 125 per cent that can only reasonably be reduced in the context of lower interest rates.

One has to hope that, in setting the pace of tapering, the Federal Reserve does not make the same mistake Mr Rosenberg makes of overlooking the impact of higher US interest rates on the rest of the global economy and of treating the US economy as if it were an island disconnected from the rest of the world economy.

Desmond Lachman, American Enterprise Institute, Washington, DC, US

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