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Central bank's rise comes at economy’s expense

By Tan Haojun (Global Times)

08:16, May 04, 2012

According to a report released last week by Standard Chartered Bank, the People's Bank of China (PBC) has become the world's largest central bank, surpassing the European Central Bank (ECB) and the US Federal Reserve.

The PBC is now not only the biggest central bank in terms of total assets, but also because it is the world's largest supplier of global liquidity, according to the abovementioned report. Specifically, its total assets reached 28 trillion yuan ($4.5 trillion) as of the end of February, compared to the $3.5 trillion held by the ECB and the Federal Reserve's $3 trillion. Furthermore, in 2011, China's broad money supply (M2) accounted for 52 percent of the world's total.

Although the PBC's new status may give it more sway in the world of global banking, the nation has paid a big price to see the central bank reach such heights. Mounting M2 has led to rising inflationary pressures and the PBC's expanding asset base has come at a substantial financial cost.

Over the past five years, the PBC has seen its M2 increase by a dangerously fast pace of 146 percent to reach $13.8 trillion as of the end of February. At the end of 2011, China's M2 to GDP ratio reached 189 percent, while the ratio for most developed countries stands at below 100 percent. In the US, for example, the ratio stood at 64 percent at the end of last year.

Surplus money supplies are especially hazardous for China, as the yuan can only be circulated on the mainland, a situation which pushes up the risks of inflation as monetary policies ease. Over the past two years, sharp M2 increases have helped create bubbles in speculative sectors and have directly contributed to sharp price spikes, especially for daily necessities such as pork and vegetables.

With regards to the central bank's swelling total asset balance sheet, this has mainly been enlarged by foreign exchange assets purchased by the PBC in order to stabilize the yuan's exchange rate. These gains in foreign exchange assets have led the PBC to increase reserve requirement ratios and step up reverse repo operations to ease liquidity, both of which have required the bank to pay large sums of money in interest. From 2003 to 2010, it is estimated that the PBC paid 1.08 trillion yuan to drain capital from the market, according to China Business News.

Currently, I fear that regulators are relying too heavily on expanding bank credit, which has contributed to the recent M2 boom, and reserve requirement cuts to combat the slowing economy. The government should instead focus on fiscal stimulus policies, such as tax cuts, to keep the economy moving forward.

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