China Smiles and Waits as World Cuts Rates

(Bloomberg Opinion) -- China's state-driven economic model has created many problems. Monetary policy isn't one of them.

With the U.S. Federal Reserve cutting rates this week and the European Central Bank poised to follow suit in September, the temptation is high for other central banks to fall in line. More likely than not, the People's Bank of China will sit tight, watching developed nations play out what is a zero-sum game.

Increasingly, developed nations' central bankers are using up the ammunition they have available to support their economies in the event of a downturn. That's particularly evident with the Fed this year. The probability of a September rate cut jumped to 95.6% from 62.7% on Thursday night after President Donald Trump threatened to escalate his trade war with China again. Yet the dollar keeps appreciating, much to his annoyance. Unfortunately, a stronger dollar damps expectations for consumer inflation, the key metric Fed Chairman Jerome Powell is trying to lift.

One key reason why the dollar isn't responding is that all the big central banks are easing, canceling out each other's efforts. This means that when a real crisis hits, they'll have less ability to respond. This is worrying because U.S. corporate balance sheets have been compromised by a decade of easy money and a wave of debt-fueled buyouts by private-equity firms.

By now, these central banks are hostage to traders and politicians. Powell had no choice but to cut rates Wednesday, because to take no action would have unleashed a cataclysm on markets. Traders and investors have been conditioned to expect steady support from central banks and react like spoiled brats when it isn't forthcoming. This kind of behavior is unlikely to go away anytime soon, as my Bloomberg Opinion colleague Mohamed A. El-Erian has written.

By contrast, the PBOC isn't intimidated by traders. One doesn't need to look far for evidence. China's 10-year government bond yield is relatively unchanged since the end of 2018, while there's been a half-point compression in its U.S. equivalent, flattening the yield curve once again.

I'm not saying the PBOC is independent; far from it. China's central bank in one sense is the world's least independent because it's forced to heed the will of the Politburo, headed by President Xi Jinping. It's a foregone conclusion that China won't cut rates right now, because the latest Politburo meeting used the key phrase that “an apartment is to be lived in, not speculated on.” That's code for “keep home prices stable,” which Xi has made a linchpin of his political legacy. In recent years, each time the PBOC reopened the liquidity taps, a real estate bubble inflated.

But what China's policymakers can do is to discipline traders and take the long view – something Western central bankers are finding increasingly difficult. And they have more in their toolbox. Unlike the Fed, the PBOC's balance sheet is still fairly clean, since it didn't engage in any large-scale asset-buying program. More importantly, China's technocrats can co-ordinate fiscal and monetary policies, a state of affairs that Western advocates of modern monetary theory can only dream of.

When the dust settles and China is sitting pretty, its market will look more alluring to global investors. Will developed nations regret undermining central bank independence as much as they have in recent years? Perhaps. More likely than not, China's policymakers are smiling right now.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.