Macro catch-phrases for 2008/9: “excess liquidity”, “co-ordinating” Fiscal and Monetary policy

Reading Bloomberg, I noticed (to my surprise) that China appears to be breaking away from the peloton on this one – although, being an over-heating economy, they have the advantage. It also struck me that these were issues that would be buzzing around the economics and financial pages by mid-year.

China plans to better coordinate fiscal and monetary policies in 2008 to help reduce its trade surplus and mop up excessive liquidity, Vice Finance Minister Li Yong said today.

China’s money supply grew at the slowest pace in seven months in December, the central bank said yesterday, after it took measures to cool inflation and prevent the economy from overheating. China may face pressure from Europe and the U.S. to allow faster gains by its currency after the nation’s trade surplus surged 48 percent to a record $262.2 billion last year.

This harks back (like, two days) to the report by the United Nations’ Economic and Social Commission for Asia and the Pacific (UNESCAP), Key Economic Developments and Prospects in the Asia-Pacific Region 2008. As well as all the cool stuff I mentioned in the previous post, the report had this contribution, vis. inflation-via-money-supply-growth:

ESCAP Figure 8

Increasing liquidity has led to growing inflation concerns in a number of countries as discussed above. China is witnessing its highest level of inflation in 10 years. India recently experienced inflation at a two-year high in January before aggressive tightening measures dampened prices.

Other than general increases in consumer price inflation, liquidity has been funnelled into purchases of particular assets driving up their prices rapidly. Some asset prices may be considered unrealistic in view of underlying valuations. The price-earnings ratio for the equity market in China stands at 59 times 2007 earnings, by far the highest such ratio in Asia. India is the only country in the region where housing prices have risen faster than real incomes over the past four years.

Major urban centres of India such as Bangalore and Mumbai have seen a doubling of housing prices in 2005 and 2006. Viet Nam has recently witnessed dramatic increases in equity and property prices. The Republic of Korea has also seen a substantial rise in property prices in some urban areas.

Managing currency appreciation has also led to fiscal costs for Governments. Foreign exchange reserves have been invested mainly in low-yielding United States government bonds. In terms of liabilities, Governments have had to pay higher rates of interest on the bonds that they have issued for the purpose of monetary sterilization.

The result has been significant costs for central banks throughout the region. The level of impact varies across countries depending on the spread between local and United States interest rates. It has been estimated that India, which has comparatively high interest rates, would face a cost in fiscal year 2007 of 2 per cent of GDP.

Another cost has been the loss in the capital value of foreign reserve holdings as the value of the dollar has steadily declined over the year. For example, China currently would suffer a capital loss on its reserves of around $50 billion as a result of a 5 per cent dollar depreciation.

With apologies to the report’s authors, I broke up the paragraphs and removed footnotes/references (page 21 of the report, if you’re interested).

The statement also mentions the use of “administrative” tools to fight inflation (due to be set at a targeted 4.6% for the year 2008), about which the Vice Finance Minister was not specific. Should be interesting: we’ve seen China’s administrative responses to inflation, already. This sounds like more of the same: price controls/ceilings (meaning shortages and more runs on goods), and/or capital controls (meaning less foreign investment – perhaps they’ll have to arrest journalists without Yahoo’s help?).

Pulling back a bit. We’ve seen the risks of all this money being pumped into our economies, here. I figure that – given the sheer amount of it all – will become a problem fairly quickly. Perhaps. The advantage of debt-backed money is that it can disappear pretty quickly, as well. The question is what becomes of all the money being pumped into the economy? Does it fill in the holes left by all the debt dropping off the face of the earth (no real net effect), or does it generate yet more Greenspanian over-investment, later in the year?


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