'Bernanke shock' necessary

The International Monetary Fund warned in its World Financial Stability Report of April 2013 that "a prolonged period of extraordinary monetary accommodation could push portfolio rebalancing and risk appetite to the point of creating significant adverse side effects". In its annual report issued on June 23, 2013, the Bank of International Settlements explicitly asked central banks to quit quantitative easing in order to secure the strong and balanced growth of global economy.

The Fed's announcement of its schedule for ending its quantitative easing coincided with a "money crunch" in China, which faces a real danger of over-dependence on unlimited liquidity supplies to keep the real estate bubble from bursting.

International experiences in the past three decades have also shown that an economy, including its currency, is relatively vulnerable to international fund flows and financial speculation if it does not have a strong, sound real economy, and thus depends too much on liquidity supplies. Germany, for example, has never worried about the US's quantitative easing policies. China needs to focus its financial sources on technology, business innovation and improving people's welfare, and it needs to take control of the liquidity supplies to the real estate sector. Local governments should suspend land supply for commercial use for six months and curb their town-making ambitions. They should also reduce their debts and let the market and businesses decide investment projects, based on feasible returns. Only in this way, can China withstand global financial instabilities.

Meanwhile, the Fed needs to carefully consider the timing and speed of its quantitative easing reduction and exit, taking into account not only the US economic situation, but also the world markets. A fast rebound in the US bond interest rates will tend to reverse the world capital flows too fast and cause instabilities, especially in emerging economies. A quick rebound in the dollar will also tend to have serious impact on other currencies, and this should be gradual as well.

The Chinese economy, while restructuring and upgrading and reducing the dependence on excessive liquidity supplies, should also maintain stable growth. A sharp slowdown in its economic growth will not only hit jobs and the capital markets, it will also hit the Asian stock and currency markets as well.

The US should gradually bring its quantitative easing to an end and China should slowly reduce its dependence on liquidity.

The author is co-director of the China-US/EU Study Center at the China Association of International Trade.

(China Daily 07/10/2013 page8)