A Study On China's Missing Money And Excess Liquidity

Since China embarked on the path of reform and opening-up, along with the rapid economic growth, the Chinese M2/GDP ratio has been rising continuously. The"excessive"money supply coexisted with lower price level, as well as the existence of large amount of"missing money", which was compounded with the relationship among money, output and price in classic Quantity Theory of Money, were characterized by the economist as"Chinese Puzzle". The economists mainly hold positive views toward the high value of M2/GDP ratio. Many economists have, for a time, kept a neutral or optimistic attitude to the variation of M2/GDP. However a remarkable change has taken place since entering the 21 century in the macro monetary economical operation of the major economies of the world. Macro liquidities were obvious excessive during 2001 to 2007, but this trend reversed sharply to extreme shortage of liquidity in 2008, because the real economy gradually stuck in the recession after the explosively outburst of sub-prime mortgage financial crisis in the second half year of 2007. Both China and foreign countries adopted eased monetary policy and active fiscal policies, which caused the sudden reversal from liquidity shortage to excessive liquidity in the first half year of 2009. Astronomical magnitude of missing money has emerged, which had ferocious impact on price indices and asset prices, then resulted in global stagflationExcessive liquidity and its reversal were widely considered to be the main source which triggers boom and bust of various types of commodity and asset price. Whether in world economy or Chinese economy, changes in monetary liquidity have played a significant role in economy operation. Monetary liguidity changes have affected physical commodities and financial assets pricing mechanism through various transmission mechanisms, and broken the equilibrium between real and virtual economy, which will not only lead to a confusing and complicated trend of inflation and asset prices, but also make the real economy succumbed to the volatility of the financial environment. Currently, the international economical and financial situation is so complicated, in which the main economies picked up again from bottom in the previous time and now have been trapped in the second recession. Under this circumstance, researches on the relationship between the missing money and excess liquidity, and the relationship among them, real economy and financial markets, are not just the theoretical problems but also practical problems that need to be solved in China's current macroeconomic policy decisions. So this paper focuses on the research of financial deepening and the coexistence of"missing money"and"excessive"money supply in Chinese economy in the environment of monetary competition. The paper expects to raise quantitative analysis to provide scientific basis for these issues.Firstly, this paper sorts out the theories of relationship among output, money and price in relation with the "missing money" and the broad money liquidity, and then gives the most appropriate analytical framework to study Chinese currency problems - internal financial deepening and external currency competition. The former is the process of economic monetization and asset capitalized. Due to the process of commodity and factor marketization, the shortage of money supply will lead to the long-term problem of missing money. The latter one, with global excessive liquidity, globalization of capital bubblization will result in general form of excess liquidity. In this line of analysis, based on the measure of"Marshall K", this paper defines and measures the liquidity and the extent of excessive liquidity or liquidity shortage, then describes the worldwide long-term trend of M2/GDP and make cross-country comparisons. Further more, this paper analyses the impact of the relationship among the excessive liquidity, the real economy, price level and financial asset.Next, with a sight on the coexistence of excess and shortage of liquidity in China recently, this paper models the monetary demand and supply functions separately, and includes the asset prices and inflation indigenously in a simultaneous equations framework with goods, money and credit markets involved. From the point of view that excess liquidity or liquidity shortage origins from the non-equilibrium of monetary demand and supply and within this analytical framework, we could analyze the effect on excess liquidity of various exogenous variables, such as external shock, policy basket adopted by monetary authorities and voluntary behaviour adopted by commercial banks. Further more, we use the Stock-Flow Consistent Analysis( SFCA) method to go into the deeper view of sectoral economy. We relate the change of monetary liquidity conditions with the sectors'assets/liabilities adjustment behaviour because we believe micro-foundation of sectoral change of asset allocation behaviour can more accurately reveal the real monetary conditions than the measures based on the macro monetary variables. After calibration parameters we use Chinese sectoral data to construct China's SFCA model with five sectors, we analyse the effect and relative importance of various external shocks, such as policy instruments, toward households'assets allocation and adjustment behaviour. Finally, we provide some advices on monetary policy and the corresponding economic structural adjustment policies involving excess liquidity management for reference.At last and based on the research result stated above, this paper gives policy advice on the management of excess liquidity and the readjustment of economic structure:I. Measures from the Original, i.e., to tighten monetary policy and control currency issuing. With the background of global excess liquidity, diversified investment should be made as risk response measure, macro policy should be focused on lowering time-spanning risks, continuous investment especially in real investment instead of financial capital should be the first and best choice for China.II. Measures of policies, i.e., to use the mixture of regulating instruments for the liquidity control. Central bank may deploy market or non-market measures to absorb liquidity, but first the risks from "outside"should be overcome and the risks from "inside" should be eliminated. Attention should be paid to opening up the source and regulating the flow of costs, and to the "absorbing measures". We should choose social security, foreign capital usage and capital market development as breakthrough to actively and steadily promote these policy measures.III. Measures of the system, i.e., to readjust the imbalanced economic structure. In response to the oversize total saving and saving and investment difference, we should adopt both general incentive for resident consumption stimulating, and special policies for enterprises and government saving reduction. IV. Measures of technology, i.e., to broaden the field of liquidity management. Controlling should not be restricted to the banking liquidity only but to the whole society. We need to set a liquidity monitoring index and to further reform China's foreign currency rate system and foreign currency management system.The innovation part of this pater includes: I. The summing-up of monitoring index system of liquidity of general money on three levels, as well as the clarification and expansion of the liquidity concept. II. The theoretical modelling of China's monetary economic operation under the circumstances of financial deepening and monetary competition. In the process of modelling China's macro and general money supply and its demand function, this paper put China's economic characteristics such as the missing money and the excess liquidity into the model scheme. III. The building of a generally balanced model of the 5 major Chinese Authorities in the framework of new-generation Stock-Flow Consistent Analysis(SFCA). By building this model this paper analyes the changes of the balance sheets of the Authorities and finds out the inside reasons of the liquidity access (shortage) in the micro mechanism.