Okay, they did it.
The People’s Bank of China finally gave the market what it wanted Tuesday by announcing it cut interest rates and the amount of reserves banks must carry.
True, it came after the Chinese stock market repeated Monday’s rout, continuing the 12% drop of the previous week. But sometimes it takes a couple of days for a lesson to sink in.
After plunging 8.5% the previous day, the Shanghai Stock Exchange Composite Index plummeted 7.6% on Tuesday to close at 2,965. It not only broke through the psychologically important 3,000-mark, but hit a level last seen in December.
This caused the PBOC to spring into action. Well, better late than never. The central bank cut the one-year benchmark bank lending rate by 25 basis points to 4.6%, and the one-year benchmark deposit rate by the same amount. It also reduced the reserve requirement ratio (RRR) by 50 basis points to 18% for most big banks.
In short, the government’s recent moves to stop supporting the market have proven it won’t support itself. Over the past month, the government has made a string of unprecedented moves such as forcing executives to buy and hold shares of their own companies. The understanding that government agencies were buying shares as well gave investors confidence to re-enter the market.
While it wasn’t clear to central committee, it was clear to all the other market participants. If the government isn’t in the market buying shares to prop it up, there’s no one else who will, even if they could, which doesn’t seem likely.
So, when the government began to makes noises that it was backing away from propping up the markets, the smart money realized the party was over. In case the government is reading Asia Unhedged, here is how the market works. If no one keeps buying shares, they don’t go up in price. If shares don’t go up in price, people look for better places to invest their money. This means they sell their stocks, pushing prices lower. It’s a very clear, linear and obvious reaction.
This led to Tuesday’s obvious reaction of the Shenzhen Stock Exchange Composite Index tumbling 7.1% to 1,749, with the small-cap barometer, the Chinext Price Index sinking 7.5% t0 1,991. The benchmark for Hong Kong’s H-shares, the Hang Seng Index, actually advanced 0.7% to 21,405.
The assumption is that the decline in the Chinese stock market is because of falling economic growth. But the reality is very few Chinese invest in the market. So, it’s not really that tied into reflecting the growth, or lack there of, in the broader economy. While it’s true that economic reports in August have been moving in the wrong direction, the world’s second-largest economy still remains one of its fastest growing economies.
Realizing that whatever remaining credibility the government has is dissipating with the stock market’s value, it needed to do something quickly. And while the rate cuts were clearly intended to make stocks more attractive compared to bonds, and to put more money into the system to get people buying, it wasn’t as ham-fisted or clear-cut as the moves last month.
In fact, it was the kind of move that a government with an economy and stock market driven by market forces would make. It’s aimed more at helping the economy than just the stock market.
“Although this has some elements of giving comfort to the market, this is more about giving a real boost to the real economy so the government can continue to have its 7% growth rate fulfilled,” Liu Li-Gang, China economist at ANZ Bank in Hong Kong told Reuters. Liu said the RRR cut was the most significant element of the PBOC action, as it would inject 650 billion yuan ($101 billion), into the economy and ease concerns of a “hard landing”.
It is entirely misleading to blame the fall in global stock markets on fears about China’s growth. China’s biggest problem, as we have argued for the past year has been excessively high real interest rates associated with the yuan’s peg to a deflating dollar. This affected the cost of credit to Chinese business as well as Chinese exports. And the source of dollar deflation has been the Federal Reserve’s misguided intention to tighten monetary policy into a weakening US and world economy.
It appears the world markets have received the message from the PBOC and they like it. In midday trading in New York, the Dow Jones Industrial Average was up 2.3% to 16,242 and the S&P 500 Index climbed 2.4% to 1,938.