On Sunday, the People's Bank of China (PBOC) cut the amount of cash banks must hold as reserves by one percent to 18.5 percent in order to spur lending and combat slowing growth. What does this central bank’s move means for the global economy and the gold market?
The PBOC introduced the second cut in the reserve requirement in less than three months after the economy decelerated to 7 percent annual growth in the first quarter, the slowest pace in six years, and the cut was unusually large in scale. The previous reduction of the reserve ratio was in February (the first move since May 2012) by the more standard half percentage point. The central bank has also announced targeted reserve requirement ratio cuts (one percent for rural credit co-operatives and village banks, as well as two percent for the China Agricultural Development Bank). The PBOC has also cut interest rates twice since November in order to spur lending, however long-term lending to the real economy has not shown much sign of reaction.
The last central bank’s move shows how the PBOC is determined to counter an economic slowdown. The cut is said to free up almost $200 billion of the banks’ reserves. It is believed that the reduction in the reserve ratio will enable commercial banks to expand their credit, in line with the money multiplier. However, in reality banks cannot lend out reserves to consumers in the economy, because they do not hold reserve accounts with the central bank. In other words, the unleashed reserves are not mechanically multiplied into new loans, since the bank lending depends also, if not primarily, on the expected risk and profitability, regulatory policies, and demand factors.
This is why Chinese banks are now very cautious about making loans (they want to reduce the amount of bad loans on their books), especially to smaller borrowers, which are already heavily indebted. And falling asset prices, when assets are used as collateral, also undercut the basis for lending.
Indeed, in March, home prices fell 6.1 percent annually and it was the biggest drop in Chinese house prices in history. Some analysts suggest that the Chinese housing bubble is bursting, which may trigger a nationwide recession, or slow down economic growth much below the still expected 7 percent. For sure, the economic situation is not rosy: trade is collapsing, while the companies are struggling with persistent overcapacity and high debt levels (China has seen more debt growth than any other major industrialized nation since the last recession). The government is trying to substitute the bursting real-estate bubble with a stock market bubble, however it can only add more problems to the current ones, once the stock prices start going down (especially that investors have been buying stocks using umbrella trusts in order to leverage themselves).
China’s weak economic activity will probably drag down the global economy and downgrade the outlook for global (including the U.S.) growth even further, which could spur safe-haven demand for the yellow metal. Although a slowdown in Chinese GDP and real disposable incomes and wealth may hinder some jewelry demand for gold, it will still remain an attractive investment to the Chinese, struggling with dropping real-estate and stock prices.
The key takeaway is that the greatest economic bubble in Chinese history is bursting, so the POMC is trying its best to provide a soft lending. The last cut in the reserve requirement is the best example of monetary easing implemented in order to counter the slowdown and spur growth. It shows that the China is struggling with severe economic ills, which may significantly affect the world economy and the U.S. itself. Any further downfall in the Chinese economy should increase safe-haven demand for the yellow metal, which would be positive for gold prices.
Thank you.
Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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