Just after the financial markets closed in Beijing on Monday, the Bank of China (its central bank) announced that is was cutting the “reserve rate”. A few hours later, the markets in Europe rallied on that news, just as they did in America when they opened. China cut the rate from 19.5% on large banks, which had just been set in February, to 18.5%, and the rate for small and medium-sized banks had dropped from 16% to 15%. But, what does that mean?
As usual, the media merely reported the news and the fact that the markets had rallied, when the markets opened on Tuesday. But, there was no explanation of what it meant. Most people took that news as indicating an interest rate cut, which might further spur the Chinese economy to rise above the projected 7.0% for 2015. But, that euphoria misses the point.
The reserve rate does not directly effect interest rates; so, it won’t necessarily lower the rates on mortgages and other loans. Banks worldwide are required to maintain a minimum of a specific proportion of their deposits on hand in order to honor depositors withdrawals. For China’s large banks, this means that they could create an additional 2.4% of loans. The reserve rate mostly just effects banks and, with that additional liquidity, it is assumed that they will make more loans, and further spur growth in the economy. But, once again, that doesn’t have any direct effect on consumers.
Meanwhile. the various fundamental jihadists are expanding their territory in the Middle East and North Africa, the fragile cease fire in Ukraine could implode at any minute, China is still irking its neighbors by trying to reclaim land near islands in the South China Sea in order to build bases, and the U.S. now has nine naval vessels in the Gulf of Aden (near Yemen) to block potential arms shipments by Iran. And let’s not forget the on-going saga of Greece potentially defaulting on its debt. That could lead Europe, a major component of world GDP, further into economic turmoil.
Given all of the hot buttons around the world, why are people getting so excited about something such as a minor expansion of lending in China, that is if it does in fact occur? I believe that within a week or two, the recent market rally will, once again, reverse itself. How many, many times has that happened in the past? And that’s just during the current year?