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Excess liquidity may lead to a new financial crisis

By Sun Lijian (China Daily)
Updated: 2010-11-05 11:06

Prices of agricultural products and bulk commodities are soaring. Currencies of emerging markets and East Asian countries, where saving rates are relatively higher, keep on appreciating.

With the inflow of a large amount of short-term capital and transition of idle industrial capital to financial capital, some countries have to adopt interest rate strategies and strengthen their capital management to fight worsening inflation and asset bubbles.

One of the tasks for major developed countries is to exit from stimulus measures as soon as possible to curb excess liquidity.

This is important because as the market revives, assets that lacked liquidity during the financial crisis will begin to "restore" its original liquidity, while liquidity injected by the government during the crisis has not find new investment channels and will become excessive.

If the real economy does not recover in time to absorb idle capital, the scale of liquidity would be enlarged through snowballing of bank credit.

And excessive liquidity would flow into the property and commodity markets and be used for speculation. Once the inflation and asset bubbles created by high costs go out of control, the negative impact on the global economy will be more profound and lasting.

The second task for these nations is to set up a comprehensive international coordination mechanism to prevent the growing "beggar-thy-neighbor" policies.

Since the 1990s, the world economy has been developed in the context of globalization.

If the United States and countries in Europe today continue to take ultra-loose monetary policies, while implementing trade protectionist measures, the increase of national savings and asset bubbles would be inevitable.

What's more, this economic expansion strategy from the US and Europe would ultimately result in the lack of growth momentum, decline of purchasing power and increase of opportunity cost in emerging markets, and it would deteriorate the worldwide economic recovery.

The third task is to find new economic engines for the world economy as soon as possible to avoid the fierce protectionism.

Many emerging countries, including China, are trying to change their economic dependence on the US and Europe. But if the recovery of the real economy does not keep up with that of the financial system in industrialized countries, there would be a shortage of motivation for cooperation because of their different stages of development.

The US and Europe should shoulder most of the responsibility, and the other countries should strengthen economic cooperation with the US and Europe in terms of funding and human resources.

Together they should create economic growth engines and create a healthy and orderly environment for globalization.

For China, the tasks would be more difficult. It needs to pay more attention to pressure from increasing credit in the banking system and to the phenomenon that an increasing number of people put precious investment into the real estate market in first-tier cities.

It must curb the capital flow from industries to the financial sector for speculative profit. The country also needs to curb the enthusiasm of local government in encouraging banks to provide easy loans.

In addition, China must encourage its wealthier people to consume, to support innovation in private enterprises and to strengthen regulations to reduce the risk of speculation in China's immature financial markets by capital overseas.

In short, if we do not act quickly, the result of excess liquidity will result in only more serious inflation, but also a new financial crisis after capital withdraws from the highly speculative real estate market.

Therefore, China should pull away from its stimulus measures during the beginning stage of the 12th Five-Year Plan (2011-2015) period, while ensuring employment and keeping a lid on inflation when setting monetary policies.

The author is vice-dean of the school of economics at Fudan University in Shanghai.