October 4, 2023

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The economic shock from China and why we should have expected it

The economic shock from China and why we should have expected it

Written by Daniel Moss

In a year of unpleasant surprises from the Chinese economy, here’s a development we should have been expecting: The country’s central bank cut interest rates. With disappointing growth and slumping prices, Tuesday’s easing by the People’s Bank of China (PBOC) should have been almost a foregone conclusion.

The fact that such an official response to the country’s poor economic performance is considered “folly” speaks volumes about how opaque the People’s Bank of China operates, compared to the central banks of the rest of the major economic powers. It also says a lot about how many expectations need to be redefined. The world is so used to China’s enviable economic results that it is hard to understand what happens when slow growth becomes the norm rather than the exception.

The monetary authority lowered the one-year lending rate by 15 basis points, a slightly larger cut than it did in June, but a relatively modest adjustment by the standards of the US Federal Reserve and European Central Bank. Moves up or down in borrowing costs – in the closed club of central banks – tend to be in the range of 0.25% or 0.50%. The People’s Bank of China (PBOC) chose to move at a fraction of those rates. Only one of the analysts polled by Bloomberg News predicted that.

a surprise! China’s central bank lowered its main interest rate


Most official macroeconomic data indicates that the economy, far from “roaring” after exiting Zero Covid policy, is seriously struggling to make significant progress. Less than an hour after the People’s Bank of China’s announcement came another batch of disappointing data: Industrial production fell in July, retail sales rose much less than expected, real estate investment continued its downward streak and unemployment soared. Alarmingly, the Office for National Statistics said it would suspend publication of youth unemployment figures. Recent reports showed a jump in the number of newly unemployed.

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The new head of PBOC, Pan Gongsheng, seems determined to prove that initial predictions that he was a “hawk” were far from the truth. That’s right. In the realm of monetary policy, conditions shape policy, not central bankers’ preferences. If Ban had chosen to avoid Tuesday’s action, what did he have in mind? And why were commentators biased towards a more conservative approach, which they saw as more likely?

The People’s Bank of China is not prone to dramatic shifts, and its officials have made it clear that while the economy could use some monetary easing, they remain wary of mounting debt. Beijing is closely watching the yuan, which has fallen about 5 percent against the dollar this year, the largest decline among Asian currencies after the Japanese yen. The government does not want a rapid decline.

part of the whole

It’s also not clear if the real estate industry is in such dire straits and the economy is suffering from a widespread lack of demand, that sharp interest rate cuts could actually lead to a significant improvement. Capital Economics, the only company surveyed to have reneged on its forecast for the PBOC’s move, believes this latest downgrade is only part of the picture. Stay tuned for further action, as Julian Evans-Pritchard, Head of China Economic Analysis writes:

Interest rate cuts of this magnitude would not, by themselves, have much of an impact. They partly reflect the recent increase in real interest rates due to lower inflation. However, the PBOC tends to use changes in interest rates as a signaling tool, with the most important work done through other tools, such as adjustments to reserve requirements and bank lending ratios. Today’s downgrade indicates that these tools will also be expanded, in line with the People’s Bank of China (PBOC) commitment to further monetary easing.“.

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The problems in China’s recovery are finally starting to disappear on the shores of the United States. The recovery has been on the back burner for some time now, but the arrival of the downturn in July looks like a bit of a turning point, at least in the public consciousness. Last week, US President Joe Biden called China’s faltering expansion a “ticking time bomb”. Treasury Secretary Janet Yellen, far more cautious, called China’s problems a “risk factor” for the United States. Fed Chair Jerome Powell will almost certainly be asked about this in his press conference after the FOMC meeting in September – if not before.

Normal life is like shock and awe

China’s economy – what a shock, what a horror! Moves in circles. With a detached cold eye, a dilation of 5% or 6% still looks good. However, a drop to close to 4% or, over time, 2% to 3% seems like a disaster. This was always bound to happen. Five years ago, the Organization for Economic Co-operation and Development made an attempt to model the world to 2060. And while China’s share of global output will continue to grow for at least a decade, its GDP will eventually start to grow much less vigorously. The United States or Europe – not China in the 1990s or early 2000s.

Crashes, and even downtimes, will become more frequent. Some are just a normal part of growing up. The real surprise might be that it took this long to continue.