Excessive liquidity could be good for China

11/30/2010 Source: Xinhua

As a currency phenomenon in nature, inflation in China, like that in any economy, is pushed by the excessive money supply on the market. While it is necessary to tighten the monetary policy, as what China is doing now, it is also important and possible to create more investment opportunities to benefit from the excessive liquidity, People’s Daily reported on Monday.

The mounting pressure of excessive liquidity on the economy comes from both internal and international markets. Between 2003 and 2009, the growth of China’s M2, the broad measure of money supply including cash in circulation and all deposits, is 2.8 percentage points higher than that of GDP plus CPI. That gap widened to more than 9 percentage points between 2008 and the third quarter of 2010. As a result, China has the world’s largest money stock, reaching 10 trillion U.S. dollars.

The inflation expectation has been further fueled by the latest quantitative easing move by the U.S. Federal Reserve, which declared it will pump 600 billion U.S. dollars into its economy. The People’s Bank of China, the central bank, has taken measures to rein in the liquidity. Commercial banks are required to raise their deposit reserve ratio to an unprecedented high level of 18 percent.

However, that is only one side of the coin. A huge economy in the process of industrialization and urbanization like China needs a strong financial powerhouse, which means the possibility of using the money more effectively.

The real economy, for example, still needs more investment. The problem, however, is that market access to some lucrative industries, including transportation, telecommunication, energy, utility and financial services, is too high for non-public enterprises. As a result private capital has made speculative attacks on property or commodities, even garlic and cotton. In that sense, the solution is to break the monopoly of state-owned enterprises in those sectors and give more opportunities to private capital.

In addition, there is a big regional disparity in terms of the capital pool. The eastern part of China holds 60 percent of the bank loans, while the rest of the country, including the central-western regions and northeastern areas, share the remaining 40 percent. About 80 percent of the loans have gone to the urban areas.

China’s outbound direct investment only accounts for 1.3 percent of the world’s total FDI. More capital flow to the mid-western area and more Chinese capital outflow will not only reduce the liquidity pressure within the country, but also will facilitate the transformation toward a more balanced growth model.

A more diversified, more developed financial sector also helps absorb excessive money. It is a good opportunity to make a bigger, stronger financial market.

The paper recognizes the difficulty in any quick effect of those measures. However, given the prospect of excessive liquidity for a long-term period in China’s economy, it is urgent to take actions immediately to take full advantage of the liquidity, according to the paper.

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