Oh shit

I woke up this morning and read this news…

China’s central bank has cut the amount of cash that banks must hold as reserves on Sunday, the second industry-wide cut in two months, adding more liquidity to the world’s second-biggest economy to help spur bank lending and combat slowing growth.

http://www.theguardian.com/world/2015/apr/19/chinas-central-bank-cuts-reserve-ratio

This is really not good news.

In fact the question is, whether more liquidity in China will help China overcome the problems China is facing?

This no doubt will accelerate the collapse world wide.

China has managed its excessive growth and its inevitable contraction far better than other advanced economies. I am of the opinion though, that these rate cut highlights the simple fact that there are far bigger problems that the Peoples Bank of China (PBOC) are attempting to address.

Interest rates are used as a policy tool to define the inflation rate, interest rates were increased substantially to combat increasing inflation. The purpose of these cumulative rate cuts now, was to increase the inflation rate, but at the same time, reducing the output growth rate, and changing the Banks attitude to lending.

The Chinese economy is facing strong downward pressure. The recent trade data also showed a retreating surplus. The slump in exports, is a clear sign that the the global economic situation is far worse than expected, together with the situation of yuan’s exchange rate being overvalued (as it is pegged to the USD) against a backdrop of a sharp decline in imports reflected sluggish domestic demand.

Yes sluggish domestic demand.

On China’s domestic loans one must remember, that the state-owned enterprises (SOEs) do not have a problem with borrowing money. Their capital is from the taxpayers, they have the government to bail them out when necessary, and they are the banks’ prime customers.

It is the small managed enterprises (SME) that are suffering from financing troubles, and they are in an inferior position when applying for bank loans. The PBOC needs Banks to lend to SME’s to allow that social capital to stimulate the real economy and thereby cutting the deflationary trend.

Conversely, banks are increasingly cautious in issuing loans out of fear of non-performing loans, amongst other risks. Banks need to lend to SME’s but one fears that they discriminate against these businesses thereby stifling funds to the real economy.

Social capital can stimulate economic growth only when it enters the lower echelons of the real economy. Similarly, the influence of an interest rate cut should be felt by the real economy before curbing deflation.

The question is, after consecutive rate cuts and now increased liquidity will this ultimately solve the current economic difficulties?

This shift by China from an export based economy, to a consumer based economy is a long process. It is obvious that problems were apparent some time ago and that is shown in that the bubble in real estate has finally burst and excess funds are now being invested in equities, fueling a bubble on the Chinese and Hong Kong stock markets.

This will not end well when these stock markets crash it will destroy capital. This capital destruction will fuel the start of their depression.

The repercussions for China are enormous, as too the world. The contagion on equities will spread.

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