Watch out for deluge of speculative money

16:16, December 01, 2010      

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The global post-crisis economic narrative has changed, suddenly and ominously, as the United States, fearing a Japan-style deflation and long contraction happening on its land, runs desperate in printing mountain-high dollar bills to flood the money market. The move, whose effects on jumpstarting a dormant U.S. economy are far from ensured, could have wild complications for others' economies.

The U.S. Federal Reserve has embarked on a new round of "quantitative easing", purchasing $600 billion in Treasury bonds over the next eight months. The first round of Fed quantitative easing, from November 2008 to March 2010 saw the U.S. central bank buying $1.75 trillion of government debts. The two bouts of easing are predicted to bring about at least 3 percent growth of products and services in the United States in 2011.

However, the huge volume of extra-budget dollars, created "out of thin air", will not sit idly on the bank accounts in the United States, but find its way to spill over to major emerging economies where opportunities abound. As usual, its entry brings price rises and asset bubbles, and its retreat leaves a blood bath of casualties. We have seen its wrecking havoc in Thailand, Hong Kong, South Korea and Japan in 1997-98.

It has taken an aim at China. The country's central bank said over the weekend that in October alone, $78 billion worth of foreign currency inflows were detected, a staggering rise of 80 percent over September. Of the influx, the bank found $43 billion belonging to speculative "hot money", funds that are highly maneuverable and often seek stellar profits in equity asset speculation. The heightened inflows of foreign currencies are making China's economy management much more difficult.

Leading Chinese economists and policymakers are said now burying their heads in the numbers and analyses, but they seem to face a dilemma on getting it right to draw the next important roadmap to continue the country's economic success story. An uptake in inflows of foreign funds has obviously caught China off guard, causing prices rises across the board that, if not controlled, translate into severe inflation in the coming months and protests by the people, the disgruntled and disadvantaged low-class, especially.

The conventional wisdom is for the central bank to raise interest rates at quickened pace. But, by making bank lending more expensive, it stifles private sector investment, kills jobs and dampens economic growth. It will also have the collateral effect of attracting more overseas "hot money" to China. For decades, the policymakers are very careful to use rates to curb inflation. The leaders are reportedly to make next year's inflation ceiling at four percent rise, compared to this year's three percent, which has immediately drawn the wrath of many online bloggers.

By tolerating a higher inflation expectation, the policymakers seem to shepherd a non-stop rapid economic growth that generates crucial jobs for tens of millions of Chinese youth and ensures social stability. The weighing on growth and jobs over inflation control is strewn with risks, for the pensioners and the poor living on government handovers will have to endure more hardships and lowered living standard because of inflation. A few days ago, poor rural students in Guizhou Province, Southwest China, have staged a rebellion against steep price rises of food in their cafeteria.

On how to cope with the torrents of foreign currency inflows, academic debate has been vehement. The central bank, headed by Governor Zhou Xiaochuan, has dominated the debate with his famous "storage pool" theory, which Zhou and the central bank have not elaborated in detail. Most economists believe the central bank draws an analogy of the pool to the required reserves of the commercial banks. In practice, within fortnights last month, the central bank twice ordered the required reserves of all lenders be raised by 50 basic points apiece, stacking up to 100 billion yuan which otherwise would be loaned to businesses.

Zhou, according to media reports, has confidence in preventing "hot money" from creating asset bubbles and economic tumults. He has indicated that when the speculative overseas money exits, the central bank will "let it go from the pool", by reducing the required reserves accordingly.

To prevent "crocodiles" of speculative funds from meddling China's economy and usurping unwarranted hefty profits, the government shall also cooperate with the central bank by stiffening control on price manipulation via malicious hoarding and spreading of false information. For sure, penalties for the offenders should be increased. On equity markets, the government needs to strictly restrict the number of homes a registered Chinese or foreign national can buy. As I wrote earlier, a basic price stability of China's property market must be kept, which, if left unregulated, could shoot to new record highs and create astronomical dangers to the country's economy in the future.

In light of U.S. heavyweight "quantitative easing" bids, the sluice holding deluges of speculative money has been lifted. The fate of China's economy and billions of people's livelihoods are at stake. Consequently, controlling credit flooding is the catch phrase for 2011.

By Li Hong, People's Daily Online


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