A key interest rate has been cut to stimulate the economy. Sound familiar?
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It's becoming an old story, but this time there's a difference. This time it could actually help the economy -- and maybe even deposit interest rates.
What is the crucial difference? This time, the interest rate cut occurred in China.
Surprise move to pep up the economy
Unlike the U.S. Federal Reserve, the Chinese central bank has not launched a new transparency initiative, and its meetings are not highly-anticipated media events. So its recent announcement to cut interest rates by 25% seemingly came out of nowhere, and was a pleasant surprise for the financial markets.
China's move to cut rates is its first since the 2008/2009 financial crisis. As was the case back then, the decision was a response to both global and domestic concerns, because even in an economy still transitioning from communism, global and domestic economic issues are closely intertwined.
Global growth matters to China because it is a major exporter. When in the U.S. or Europe falter, China sees potential weakness in key markets for its goods. Also, China has become a huge creditor to the world. It holds the debt of the world's major economies, and does not want to see that investment compromised.
Domestically, China needs growth to manage the transition of its economy. As more and more of its people migrate from rural to urban regions, it needs the type of job creation that will keep these new concentrations of population productively employed. Handled correctly, that type of growth can become self-sustaining, but monetary policy can help smooth out any bumps along the way.
East is east and west is west
After interest rate cuts have failed to stimulate growth in the U.S. and Europe, why should there be faith that rate cuts in China will be any more effective?
The difference is that while consumers and many governments in the western world are in debt, China is flush with savings, both at the national and individual levels. Cutting interest rates to encourage spending has done little good in the U.S. and Europe because consumer are already tapped out. In China, however, cutting loan rates and savings account rates will encourage its people to spend a little more of their savings and become a more consumer-oriented society.
In other words, for cutting interest rates to act as stimulus, there has to be an additional capacity to spend. This is more true in China than in the West.
What's in it for bank rates?
Why might this help U.S. bank rates? Because stimulus in China can help growth globally, without pushing bank rates lower in this country.
So far, U.S. depositors have been asked to suffer low savings account rates on faith. The premise is that if you accept low bank rates now, the growth they stimulate will allow those rates to rise later. But after more than three years of waiting, U.S. depositors have learned not to hold their breath waiting to get repaid for low bank rates.
In contrast, when China lowers its rates, it shouldn't cause U.S. rates to fall, but the stimulus that results may ultimately help the U.S. economy -- and its bank rates -- recover. So this time, things really may be different.
The original article can be found at Money-Rates.com:China's rate cut: Good news for the US?