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History is replete with examples of central banks that have aborted incipient recoveries from deep recessions by premature policy tightening. The U.S. Federal Reserve famously did so in 1937 as did the Bank of Japan on a number of occasions in the 1990s. One has to wonder whether the Reserve Bank of Australia might now not be making the same mistake by being amongst the first of the world's major central banks to hike interest rates.

In raising interest rates, the Reserve Bank is making a bold bet. It is essentially betting that the global economy is on the cusp of a V-shaped recovery that will keep international commodity prices well bid. Yet it is far from obvious that this will be the case. After all, there are all too many reasons to fear that the U.S. economy could stall again early next year once the fiscal stimulus has peaked and once business inventories have been rebuilt. And there are all too many reasons to be deeply concerned about the strong headwinds that renewed deflation in Japan and growing tensions within the Euro-zone pose for a meaningful global economic recovery

The optimists on the U.S. economy, who by and large spectacularly failed to anticipate the Great Recession, are now grossly underestimating the negative impact that falling household incomes and household deleveraging will have on U.S. consumer demand. They seem to be oblivious to the fact that the gaps now characterizing the U.S. labor market are at their widest levels in the post-war period. They also seem to be ignoring the fact that, absent a strong economic recovery, these large gaps will more than likely persist in 2010 and they will continue to exert substantial downward pressure on wage incomes.

Stagnating or falling incomes would constitute a serious problem for the U.S. economic recovery at the best of times. However, these are hardly the best of times for the U.S. consumer. With household debt levels at around 135 percent of their incomes, U.S. consumers have never been as indebted before as they are today. Making matters all the more serious is the fact that they are still reeling from the recent destruction of around 80 percent of GDP in their wealth that has occurred as a result of sharply lower home and equity prices.

Further clouding the U.S. economic outlook is the fact that the U.S. commercial property market appears to be in freefall, even before a large volume of commercial property market loans are set to fall due in 2010.  At the same time an expected new wave of home foreclosures in the months ahead is likely to delay the eventual stabilization in U.S. home prices.

The dangerous trajectory on which the U.S. public finances now finds itself has to raise the real risk of a dollar crisis in the not too distant future. Foreigners already own more than half of all outstanding U.S. Treasury paper and they are now being called upon to finance an even larger proportion of the large prospective U.S. budget deficits. Foreign central banks are already expressing their discomfort with their large U.S. Treasury holding, while market fears seem to be surfacing that in the end the U.S. might resort to inflating its way out of its debt problem. 

Doubts about the U.S. economic recovery, while certainly of the greatest importance for the global economy, are not the only factor clouding the global economic outlook. Debilitating deflation has once again reared its ugly head in Japan, the world's second largest economy. At the same time, an overly export-dependent German economy would also seem to be counting on a vigoroU.S. global economic recovery to sustain its incipient economic rebound.

Of greater concern for the global economic recovery than Germany's likely lackluster performance next year are the acute strains now manifesting themselves in the Euro-zone's weaker member countries. Portugal, Spain, Greece, and Ireland are all now in the throes of deep economic recessions that are wreaking havoc with their public finances. At the same time, all of these countries are being weighed down by the large loss of cost competitiveness that they experienced over the past decade but that as members of the Euro-zone they are unable to remedy with any change in their exchange rates.

The optimists are hoping that rapid economic growth in China might somehow provide the underpinnings for a strong global economic recovery. However, they seem to be overlooking how meaningfully China's bold stimulus. measures over the past year have been so heavily focused on expanding China's industrial capacity that has only further exacerbated the global excess industrial capacity problem. They also seem to be overlooking how reliant China's policy stimulus has been on an unsustainable expansion of bank credit, which has given rise to a series of asset price bubbles and which is now having to be reined in.

One must hope that the Australian Reserve Bank's bet on a V-shaped global recovery turns out to have been the right bet. However, judging by the all too many economic flashpoints around the globe, the Reserve Bank's bet would seem to be anything but a sure thing.

Desmond Lachman is a resident fellow at AEI.