The U.S. stock market is an economic barometer that policymakers from around the world follow closely, and when those policymakers take action, what they do often moves stocks dramatically. On Wednesday, China's central bank made a key decision to try to spur economic growth, but despite the implications for the global economy, stock markets in the U.S. didn't respond much. The Dow Jones Industrials (DJINDICES:^DJI) were relatively flat shortly after 11 a.m. EST, reflecting solid earnings results from Walt Disney (NYSE:DIS), while the S&P 500 (SNPINDEX:^GSPC) and other broader-based benchmarks were even closer to the breakeven point.
Why China is looking for more growth
The Chinese central bank decided on Wednesday to reduce the amount of cash reserves that its banks have to keep on their books, lowering the reserve requirement ratio half a percentage point to 19.5%. Chinese officials hope the resulting flexibility to extend more credit and take on more leverage will spur greater lending to the domestic Chinese economy. In particular, the bank called out small businesses, especially in rural areas of the nation, as well as the construction of water projects and other infrastructure-improvement efforts, as the driving force behind the move.
The move follows other efforts that China has made recently to stimulate its economy. Last fall, the world's second-largest economy reportedly made more direct attempts to encourage greater lending within its financial industry, giving its five largest state-owned banks low-interest loans that it could turn around and use to extend credit to their customers. In total, those loans added up to more than $80 billion.
One question many Western investors might ask, though, is whether China truly needs to reignite its growth. The Chinese economy grew at a 7.4% pace in 2014, and while that's just shy of the 7.5% growth target that China has, it nevertheless puts even the booming U.S. economy's growth rate to shame. When you consider the recessionary conditions that many economies in the eurozone face right now, combined with the economic struggles in Japan and other areas of the developed-market world, China's growth seems lightning-fast by comparison.
Indeed, some policy analysts believe China would be better off not emphasizing overall economic growth. A 2013 article from Michael Pettis at the Carnegie Endowment for International Peace argued that the more important hurdle China faces is how to rebalance its economy so that it's driven less by industrial exports and more by domestic consumers, as the latter model is inherently more sustainable and in some ways self-perpetuating. Moreover, as the economy grows, Chinese citizens will focus more on their own household income growth, which has historically lagged GDP growth. If China can reverse that trend so that household income rises faster than GDP, then it could set the stage for a self-perpetuating growth rate -- albeit perhaps at a slower pace than today's levels.
Why U.S. investors should watch closely
Despite today's lack of response, U.S. companies have increasingly looked to China and similarly fast-paced growth areas as sources of financial opportunity. The strength of the U.S. dollar has masked the success that many U.S. multinationals have had abroad, with currency effects holding back dollar-sales growth but reflecting considerable gains in local-currency revenue. As China keeps growing, companies that are most effective in tapping opportunities there could see their own growth accelerate dramatically.
As a result, U.S. investors need to keep an eye on conditions in China and elsewhere in the emerging-market world. With the global economy showing widely disparate conditions in different regions, only by looking at the worldwide economic picture can you get a true sense of where things stand and where your best opportunities are to profit from current market trends.