The Federal Reserve and most economists believe that keeping US interest rates at near zero has been critical to the recovery of the American economy. Even with rates at historically low levels, banks and financial companies have been stingy in their lending practices because of the fear of risk from providing capital to people and businesses whose financial positions have been crippled by the recession.

Fed officials have hinted that the agency may not move rates up at all until 2011 because unemployment and tight credit will only allow a very fragile advance in GDP between now and then.

China would like the US to raise interest rates based on its theory that the low cost of capital is causing massive speculation in equity and commodities markets. China claims that Fed policy will cause bubbles that will burst and cause both another sharp downturn in the global economy and damage to the credit markets.

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Liu Mingkang, chairman of the China Banking Regulatory Commission, said in comments reported by Bloomberg that “The continuous depreciation in the dollar, and the U.S. government’s indication, that in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation.”

It is a matter of debate whether asset inflation is a major problem. Last week, the CEO of Exxon Mobil (NYSE:XOM) said that the price of oil is $20 higher than it would be if the dollar was not especially weak. He said that global crude supply was more than ample to handle the current very modest increase in demand.

The price of crude is not the only fact supporting Liu Mingkang’s case. The price of gold was $874 an ounce a year ago. The metal traded at $1,117 last week, a rise of 32% over the period. The DJIA is up over 40% from its March lows and the Nasdaq is up over 50% during the same period. The only major asset is  thestill rapidly losing its value in the US is real estate. That ongoing drop could be tied largely to unemployment. The irony is that low interest rates are supposed to help businesses get cheap access to capital which should increase hiring.

Liu Mingkang’s case will fall on deaf ears, at least in the US. China has its own $585 billion stimulus package which has provided enough liquidity to the economy of the world’s most populous nations to create sharp increases in prices of equities and real estate. The value of stocks in China’s Nasdaq-style stock market, ChiNext, rose an average of 200% on the first day that the new exchange was open.

China’s banking authorities may be right. Low interest rates in American could cause inflation in some asset classes. The problem is that without rates near zero, the US economy could face another catastrophe.

Douglas A. McIntyre

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