Hail for central bank's digging a 'pool'

10:46, January 18, 2011

By Li Hong

The U.S. Federal Reserve's extraordinary easing policy is creating two bubbles that don't bode well for all of us: a stock market bubble at home, and commodity price bubbles abroad. When the bubbles explode one day, few will be left unscathed, with deeper and bloodier scars cut on the trunks of major economies.

It is sensible for President Hu Jintao, who kicked off his second state visit to the United States today, to "prod" the U.S. on its risky "quantitative easing" (QE) monetary policy, because it will prove to be monetary bungling. Although the Federal Reserve stubbornly believes in "flooding the U.S. with dollar bills" to stimulate a contracted economy and create jobs, more and more economists have distanced themselves from the Fed's radical move, drawing analogy to "playing with fire".

The Chinese president has urged the U.S. government to maintain monetary accountability by keeping the liquidity of the dollar "at a reasonable and stable level". Now it looks increasingly crystal that QE devalues the dollar, triggers price bubbles and inflations in others' market and creates an unstable world, which will come back to cripple the American economy and drag it back to painful recession.

"In a desperate – and doomed – attempt to return to pre-crisis 'business as usual' days, Western policy makers have unleashed inflationary pressures elsewhere in the world, which have only served to make the recovery in the West more difficult," HSBC's group chief economist Stephen King said in a recent speech in Hong Kong.

The unintended consequences of QE are now felt by emerging countries. Take China for an example, in the past six months, the country's central bank has reversed its previous stimuli and implemented a fairly tight monetary policy. To rein in rising asset prices and inflation, it has kept raising banks' reserve requirement ratios, twice hiked interest rates, and strengthened the value of its currency.

Although China may pull along with a proactive fiscal policy and monetary policy maneuvering, and is expected to attain 8.5 percent economic growth in 2011, as compared with 10 percent last year, other emerging economies could find the heat hotter to achieve enviable growth as before. To thwart rising inflations, these countries will have to raise interest rates in 2011, which discourages private sector investment and weakens growth.

In "abnormal" time – U.S. Fed's excessive easing couple with a forced monetary tightening by the emerging countries, it is important for the policy-advisors and makers to think creative, big and far-sighted. China has done not a bad job.

To hold back overwhelming inflows of overseas "hot money" to China, significantly resulting from QE, the People's Bank of China, the central bank, has dug a "storage pool" to keep the excess of money from wrecking havoc in China's financial system. First put forward by Mr. Zhou Xiaochuan, the central bank governor, the theory has to be tested by time. Zhou's bank has raised lenders' reserve requirement ratios seven times in the past 12 months that locked up tens of billions of yuan in the "pool". If not for the "pool", China's inflation could have hit more than 20 percent now.

The record increase of US$200 billion in China's foreign reserve from October to December speaks of the rising tides of overseas "hot money" flowing to the country. Ma Delun, Zhou's deputy, revealed that Beijing has been printing the yuan bills 24 hours to exchange for the inflows of the "hot money". It is almost certain that China will raise the reserve requirement ratios again in 2011 to captivate more liquidity in the "pool".

In addition, the central bank has approved some Chinese banks abroad to allow foreigners to open yuan accounts, to test overseas demand of the Chinese currency, and also, to channel some of the printed yuan bills aboard to alleviate domestic credit crest. President Hu Jintao, writing for the Washington Post and the Wall Street Journal, has expressed the confidence of Chinese government in curbing inflation. Some economists are not that sanguine, as the challenges of capital inflows seem too difficult to tame.

However, I would say again, it is important to think far-sighted. The amassing of the foreign currency reserve will enable China to stay "above the water" in the next, more tumultuous, storm. With that money in store, one goes to bed, assured.

The articles in this column represent the author's views only. They do not represent opinions of People's Daily or People's Daily Online.