Excessive Liquidity and Bank Lending in China

Abstract

This paper analyzes two contending views of money and excess liquidity at both the theoretical and the practical levels. We relate the analysis to China's skyrocketing credit expansion in 2009 and its relationship with the housing market boom. The conventional view is that such a bubble is highly dangerous and is largely caused by great sums of "excess liquidity," which, in turn, induced Chinese banks to lend funds. This supposedly fueled the fire in real estate markets and also pushed up the stock market. However, it is unclear what "excess liquidity" is and where it comes from. Also remaining unresolved are questions about how it is affecting the real economy and what should—or could—China do to deal with such problems. We will attempt to illustrate China's "excess liquidity" situation within the framework of post-Keynesian-Chartalist "modern money" theory and will conclude that China's liquidity "dilemma" is almost much ado about nothing. However, China does face a longer term problem mainly caused by its foreign exchange regime and its overdependence on external demand. Although not as harmful as many have argued, solving this problem will require thorough understanding of the properties of modern money and of associated policy reforms. We believe that China, with its sovereign currency, can overcome these problems and can switch to a much more sustainable internal demand-driven full employment development path.

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