The Guest Blog

Busch: Chinese Rate Rise=European Frying

Ahead of a week long holiday, the central bank of China raised reserve requirements (RR) by 50 basis points.

This is the 2nd time this year they have raised the RR and underscores the monetary exit process is in it's fledgling state. Before today's announcement, large banks were at 16% RR and small banks at 14% RR. It's estimated that this will take out RMB 300 billion from the financial system and is an attempt to quell the surge in 2010 lending.

In 2009, Chinese lending was allow to expand dramatically to aid the economy.

It clearly worked with a Q4 GDP of 10.7%. However, it's coming at a cost as inflation is picking up and bubbles are appearing as the loans appear to be leaking out to more speculative areas of the economy. the immediate problem is that Chinese banks are still lending at high volume levels. This became acute in January when banks lent over RMB 1.3 trillion or 19% of the target volume for the entire year at RMB 7.5 trillion. February lending estimates are near RMB 1 trillion as well.

This early loan volume prompted the first RR in January and prompted the central bank to ask banks to call back loans made in the beginning of the month. Following this, China's largest property lender said it would raise the down payment requirement and interest rates for clients buying their second or subsequent homes. This would bring the China Construction Bank into line with other major banks that are starting to implement tougher lending requirements for people purchasing homes for speculative purposes rather than for their own use.

According to the 2009 Q4 People's Bank of China Monetary Policy Implementation Report, financial institutions' outstanding loans to commercial real estate hit 7.33 trillion yuan by the end of 2009, up 38.1 percent year on year. The volume of CRE ending is 27.7 percentage points higher than in the same period of 2008, and 6.7 percentage points higher than the total loan growth. This is adding to the angst of the global commercial real estate market and to forecast for downward pressure property values.

China and the Far East occupy a far different place in the business cycle compared to Europe and the United States. The nascent Chinese exit strategy will be a test case for other nations to follow when the cycle recovers. Given the disappointing Eurozone GDP numbers today, it appears that Europe will not need to be following this path any time soon. With the growing debt levels and subsequent servicing, Europe may experience a deflationary impact from the Chinese monetary tightening that may exacerbate the current debt problems.

Southern Europe can't resort to either inflation or devaluation to reduce their debt burdens or to increase economic growth. They are constrained by the currency and monetary union that ties them to the Euro and the ECB. This is why calls for a break up of the Eurozone will be suggested as a solution to the problem.

Until Greece and the other parts of the barnyard animal (PIIGS) agree to an IMF-like austerity measures, the EU may just be cut up for bacon.

Andrew B. BuschDirector,

Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and
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