U.S. markets are in a whirl over signs the Federal Reserve will slash interest rates later this month. It would be an epic about-face for a monetary authority in tightening mode since 2015.
Yet the most important impact might be felt 6,900 miles from Washington -- in Beijing.
As an immediate result, looser Fed policy makes it easier for the People's Bank of China to engineer its first official rate cut in four years. Beijing is anxious to support a slowing economy, but even more anxious about Donald Trump's itchy trigger finger when it comes to tariffs. Easing before the Fed might weaken the yuan, prompting Trump to up the trade war ante.
Concerns have faded as Fed chairman Jerome Powell caved to Trump's bullying. With unemployment near 50-year lows, it is hard to justify easing. Yet with the U.S. president threatening to fire Powell, political survival trumps economics. A 25 basis-point cut in the 2.25%-2.50% target is likely at its July 30-31 meeting.
The same thing is true in Xi Jinping's China, of course. Given Beijing's epic borrowing binge since the 2008 global crisis, it is hard to argue more stimulus would help. China is confronting the same diminishing returns problem Japan grappled with over the past decade.
Still, PBOC easing would check two vital boxes. One, it would allow the yuan to slide versus the dollar. That offers a dose of export competitiveness, if it can be done without trolling a Trump response. Two, it rings the proverbial gong. The first Chinese rate cut since October 2015 would signal that Beijing means business in trying to keep growth above 6%.
Easier monetary conditions are not a panacea, though. Printing more yuan alone does not ensure that banks will increase lending, particularly prudent and productive lending. Again, Tokyo's overreliance on monetary accommodation over structural reforms augurs caution.
The answer lies in the PBOC getting more bang for its yuan with easing steps. Since taking the reins in March 2018, PBOC Governor Yi Gang has churned huge waves of liquidity -- no one outside his team knows exactly how much -- into the economy.
Most of this support has been aimed at small and private companies. China's massive state-owned enterprises can tap a vast web of shadow-banking institutions. Smaller, less politically-connected operations tend to look to PBOC lending windows.
Yi's team also guided short-term lending rates lower to relieve funding constraints in the corporate sector. Those headwinds have intensified as Trump's 25% taxes on $250 billion worth of Chinese goods damaged exports. The 1.3% drop in June exports from a year ago is an ominous sign for Asia's biggest economy in the second half of 2019.
The PBOC's moves have not jump-started credit as hoped. What is more, the odds Trump will toss more grenades into the global trading system have mainland executives delaying investment plans. That explains the agreement for a big, systemwide rate cut to bolster confidence in the six to 12 months ahead.
Equally important, Beijing must accelerate efforts to increase the PBOC's traction. A series of cuts to the 4.35% one-year benchmark lending rate could backfire if it encourages huge capital outflows by investors seeking higher yields. It also could encourage a fresh borrowing binge, adding to a mountain of public and private debt already exceeding $34 trillion.
Yi has a wide array of tools from which to choose. We could see a one-off cut in the benchmark rate to set the tone. Then, he is likely to focus on a series of more technical tweaks to target any boost in liquidity.
One option is to cut the so-called reverse repurchase rate. This sort of market-centric step, which targets commercial banks, has been the PBOC's go-to response to Fed rate shifts in recent years. Cutting China's 7-day reverse repo rate, currently 2.55%, could ease short-term turmoil in the financial system.
Reducing reserve ratios also is an option. Cutting the amount of cash banks must leave on deposit at the PBOC is often a surefire way to lift credit growth. Caution is required, of course. In recent weeks, regulators have reportedly warned banks to stop lowering mortgage rates amid concerns about property bubbles. China already has as many as 65 million empty apartments. It hardly needs more.
Changes to medium-term lending facilities could enliven credit. These are the prices the central bank charges for the most expensive loans in the system. So-called MLF schemes accept a wider range of collateral, including both national government and municipal bonds and highly rated corporate loans. Expanding them could help banks pay off loans or swap them with cheaper options.
What about Bank of Japan-like yield-curve management? Last week, China's main overnight repo rate, a price for short-term borrowing in government debt, dropped to about 0.70%, the lowest since Beijing began disclosing data in 2003.
It is now below the roughly 0.72% rate the central bank offers on excess reserves held by commercial banks. Such a rate inversion makes it more advantageous for banks to hold cash than to lend, deadening the stimulative effects of PBOC policies.
What to do? China's best option is a dual assault on slowing growth.
The first relates to a recent rate-reform plan previewed by Premier Li Keqiang. In May, the State Council, over which Li presides, signaled a move to lower "real" borrowing costs -- in other words, a means of increasing the PBOC's policy traction. Li also said plans are afoot to cut loan application fees.
Yet the traction issue is the big one. Though details are few, it is wise for Beijing to increase the efficiency and transparency of interbank lending. The same goes with bringing bond-yield dynamics more in line with the PBOC's desired levels for short-term and midterm loans.
Such improvements, says economist Larry Hu of Macquarie Bank, would also increase the PBOC's influence over property markets and infrastructure projects.
Second, Yi must use his gravitas to prod Xi's government to accelerate structural upgrades. Since 2012, Xi has pledged to give market forces a "decisive" role in policymaking. Yet efforts to wean China off exports, excessive borrowing and credit and smokestack-heavy industry have taken a back seat to short-term stimulus.
Nothing would turbocharge China's effort to avoid Japan-like deflation like upgrading the PBOC's toolbox with supply-side reforms. As the Powell Fed clears the way, the PBOC will be under more pressure than ever before to raise its game. The global economy has everything to gain from its success.
William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades"