This morning China cut both their one year interest by 25 basis points and reduced their reserve ratio by 50 basis points. Of course the China skeptics were quick to point out this is the sixth interest rate cut, and so far the others have “not worked,” so why does anyone expect this one to magically be the “one?”
Maybe the skeptics are correct. The PBOC might be throwing tiny sparks on a thoroughly soaked wet campfire expecting it to be lit. Yet if the PBOC was even more aggressive, these perma-China bears would say “look! they are panicking because the Chinese economy is so bad!” So let’s just throw out the comments from all the peanut gallery and think about what these latest cuts mean.
The most interesting part of this interest and reserve ratio cut is the timing. President Xi Jinping is just returning from meetings in the United Kingdom. Next week the leaders of the Chinese Communist Party meet for their 5th plenum. At this meeting, the Chinese outline their 5 year plan.
This will be the first 5 year plan drafted up under President Xi Jinping’s leadership. Since taking office in November of 2012, President Xi has introduced a bunch of tough reforms that have hit the Chinese economy hard. He has aggressively routed out corruption. He has cut back on frivolous infrastructure projects. All in all, he has put in place many of the tough decisions that China had been delaying for too long. This has had a large dampening effect on the Chinese economy and has created a lot of pessimism about China’s future amongst investors.
Yet let’s compare President Xi’s leadership to that of a CEO. What do many CEOs do when assuming office? They front load all the bad stuff. They take all the tough action that needs to be taken, blaming it on the last guy. That way, there is nothing but clear sailing ahead.
What if President Xi has simply front loaded all the bad news? He has taken the tough action that needs to be taken, and he is now ready to grow again.
The monetary policy cuts right in front of this important planning session is a signal that President Xi is about to embark on the next stage of his leadership.
Five years ago, China could do no wrong in investors’ minds. Today China can do no right. Investors were too optimistic back then, and they are too pessimistic today.
China is still a command economy, and the policy set by government officials is crucially important. They are about to surprise everyone in their re-commitment to growth. President Xi is not just a chop and clean up CEO. We are about to see the next act in his career.
Be careful you don’t end up looking like the bear in the statue above…
Thanks for reading and have a great wk-end,