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Thursday, July 5, 2012

China's Central Bank Cuts Interest Rates Again

But while all eyes were focused on the Bank of England's monetary mumbo jumbo, and the parallel rate cut by the European Central Bank in Frankfurt, much more significant central bank action was taking place on the other side of the world – the People's Bank of China cut rates in the world's second largest economy for the second time this year. This was quite unexpected and shows that Chinese policymakers have become seriously rattled by the evident slowdown in their economy.

China is a big place – a statement of the bleedin obvious if ever there was one – and economic performance across the country has always been extremely varied. Think how divergent it can be in Europe and America – with some regions growing fast and others in depression – and magnify it a couple of times for China. As a whole, the economy is still growing fast by European and American standards, but for China, which needs to create tens of millions of jobs a year to keep pace with rapid urbanisation, it's not nearly fast enough.

Some parts of the more developed eastern seaboard may already be starting to suffer from the same sort of boom to bust dynamics that has engulfed advanced economies. Excessive credit expansion, over development, and an overheated property market – all these things are now coming home to roost. The standard view is that the Chinese authorities are well placed to counter the growing list of negatives, but I wonder.

The banking system is shot through with unrecognised bad debt, once buoyant Western export markets are in ragged retreat, and just how much more investment can the Chinese economy take before knocking up against already manifest levels of industrial overcapacity?

Even in a centrally directed economy, it's not possible to sweep these problems under the carpet for ever. The chances of a hard landing already look quite high.
Over the short term, this isn't good for anyone. A China that finds itself in the economic doldrums won't be able to buy U.S. Treasury bonds, nor help Europe with its financial problems (although even that, I suspect, is beyond anyone's ability).

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