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Expert's View
Special> Coping With the Global Financial Crisis> Expert's View
UPDATED: August 22, 2009 NO. 34 AUGUST 27, 2009
Efficiency in Liquidity Matters

While stocks plunge on investors' fears over tightening credit in China, the U.S. Federal Reserve has decided to maintain its current interest rates near zero until a sustainable economic recovery is underway. When the recovery is in sight, U.S. demand for imports will soon return, raising hopes for China's export sector—but a possible U.S. dollar rally may also cause capital outflows from emerging markets where hot money has pushed up assets prices. Yuan Zhigang, Dean of the School of Economics in Fudan University, spoke with 21st Century Business Herald about the efficiency of liquidity, and provided solutions to asset price hikes. Edited excerpts follow:

China has maintained a trade surplus for years to keep double-digit economic growth, and has hence accumulated more than $2 trillion in foreign reserves, which is in other words liquidity injected into China by other economies, the United States in particular.

But in the short term, China will not receive as much liquidity from the outside as it had previously. Instead, it will be filled with domestic liquidity, backed with a credit expansion by commercial banks.

As far as I'm concerned, injected liquidity can be used more efficiently than that of domestic liquidity expansion. It can greatly boost investment, create jobs, sharpen China's manufacturing competence and keep machines running. This will be mainly invested in private and foreign companies, whose ability to thrive will lead to a real economic revival.

But domestic credit expansions have been reportedly invested into large infrastructure projects or manufacturers through local governments and state-owned enterprises. Some of them could wind up as bad loans—if they go into the capital market for speculation before the real economy picks up.

China began to adjust its credit supply in July. But even if credit supply slows in the second half of this year, the first six months of 2010 will witness an increase in credit scale, bringing the annual new loans to 7-8 trillion yuan ($1- 1.2 trillion) for the following three years in a row.

In addition to adjustments in credit supplies, we can put into place asset price hikes by increasing the supply of asset products. We can increase initial public offerings, too, by encouraging hi-tech and energy-efficient companies to file listings, allowing equity financings and bond financing accounts for a larger share of all capital markets.

The same solution could also be applied to the housing market. An increase of land supply, plus the launch of more low-rent housing projects would not only help mitigate future increases in housing prices, but also fulfill a consumer demand for homes. The land rush by property developers recently may prop up current land prices—but it will also increase the home supplies in the future.

Much of the growing inflation concerns in China are anticipatory at the moment. In other words, a moderate inflation is a boon to economic recovery, while excessive inflation anticipation could be tricky. Amid such predictions, significant quantities of speculative hot money have also pushed up prices of commodity futures and other capital assets. Price hikes in oil and iron ore, on the other hand, could create an imported inflation in China in the short run, when there is a real inflation.

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