Learning by doing

China's Central Bank injected 500 billion yuan (approx. 63 billion euros) into the country's commercial banks this week. It was big news that made the financial world sit up and take notice. In the remaining quarter of 2014, all five of China's major state-owned banks will be receiving 100 billion yuan each.

The official word is that this is merely a routine measure. After all, Wednesday marked the start of the Golden Week, a 7-day national celebration, when virtually the whole country shuts down.

It is therefore not implausible that the public needs cash for traveling and shopping, and that's why the banks need to top up their coffers. But do they really need this much?

This is about much more than short term liquidity. The order to print money comes from the very top, since the Chinese central bank is no independent organ, but under the direct control of the Communist Party.

Conflicting Signals?

At first glance, it looks like the government is sending conflicting signals with this liquidity injection. Only last summer China's President Xi Jinping was employing quite different methods: At that time he was keen to show he was serious about the planned financial reform, under which banks would be privatized and the financial markets would be further opened up, step by step.

At short notice he turned off the flow of money to state banks causing them to lose trust in each other, and for interest rates to shoot through the roof. It was a test to show how the system was working. And interest rates really did rise. But otherwise not much happened.

Now, is it time for the backward flip? Instead of turning money off, flooding the markets. Are the reforms over? No, Beijing is still serious about its goal of financial sector reform. But the government has realized that a sledgehammer reform can easily backfire.

Reform in difficult times

Beijing would like to reform the banking sector, and the move is clearly necessary, but it has chosen a difficult time to do it: The country's industry, which urgently requires bank credit, is weakening. It is looking increasingly unlikely that China can meet its growth target of 7.5%. In August, industrial output experienced its biggest downturn since the global financial crisis of 2008.

The cash injection for banks kills two birds with one stone. First, the money will give banks the room they need to implement the reforms required of them. At the same time, interest rates on bank loans will fall. This will help Chinese industry, as well as small businesses and start-ups, to get cheaper financing.

The to and fro could have a negative effect on international financial markets, but it mainly shows that China's government cannot see into the future and will step in to correct the reform plans it is implementing where necessary.

Rumors about the central bank chief

Beijing, however, has not completely lost its head in its actions. Rumors that the boss of the central bank, Zhou Xiaochuan, could be removed surely have little to do with divisions within the government on the reform course as one could read in many places last week.

So Zhou's departure from the scene has a much simpler reason. He will soon be 67, time to retire! But thus far the central bank has denied that he is going. After all he does have an excellent reputation in the international financial world.