Response To the Chinese Government Stimulus, M↑& V↑--> PY↑

Chinese Premier Wen Jiabao, unveiling the government's economic stimulating plan for this year, reaffirmed its commitment to a 4 trillion yuan investment program and announced a record budget deficit of about 950 billion Yuan, though confusion remains over the real scale and impact of the stimulus plan.

I think the 4 trillion Yuan is only a rough figure of the spending plan. Actually about 1.2 trillion yuan will be financed by the Chinese central government. The rest will be financed by the local governments. The impact on the economy as a whole should be more than 4 trillion. Assuming the spending multiplier be 2.5, through the multiplier effect, it exerts a significant impact on the GDP. I think it will contribute about extra 2 to 3 percent of economic growth this year. The rescue action should be bold and swift ("出手要快要狠") as asserted by our Premier Wen Jiabao otherwise the unbearable economic pain may persist.

Beside the 4 trillion yuan fiscal impulse, I urge the Chinese decision-makers do aggressively manipulate the fiscal and monetary tools in order to regulate the ailing economy back to its right track in the midst of this global economic tsunami. Further stimulating domestic consumption and preventing deflation expectation hold the key to sustain the current recovery of our Chinese economy. I'm glad to know that the reaction to the stimulus package was the sharp surging in bank lending. The government report shows that she will target up to 5 trillion yuan bank lending this year. I think it can further raise the monetary base (cash and bank reserves) which gives it the right way to boost the economy.

The increase in spending in real estate property and private consumption will also stimulate the economy, as hundred of other related trading sectors will be boosted as a whole. Social security for the vulnerable groups should be enhanced. The Gini Coefficient, the indicator showing the gap between the rich and poor, is about 0.45 that is higher than those figures in Western European countries. Government assistance should help to social stability during this economic downturn. Short and medium term sustainable growth should then be maintained as the confidence be restored by such government effort.

http://wongtc.blogspot.com/2009/03/blog-post_07.html

How to avoid the coming back of the 30's great depression ?

It recalls me one of the famous economists, Irving Fisher, living in the 30's economic great recession last century after Obama was elected as the US president. Obama said, "We are facing an economic crisis…We now risk falling into a deflationary spiral that could increase our massive debt even further."

Irving Fisher's assertion is surely relevant to the global economic slump today as the real burden of debt increases whilst the stocks and collaterals shrink in value. Income is dropping as well. The process of debt-repayment, the so-called deleverage, forces the outright asset sales and further driving the asset prices down. It is a vicious cycle that leads to desperate recessional spiral. Finally, the economy may brew into great depression for no immediate correction was acted to stop it.

In the 30's great depression, Irving Fisher wrote that, "Over investment and over speculation are often important; but they would have far less serious results were they not conducted with borrowed money. The very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate…the more debtors pay, the more they owe."

Irving Fisher described "debt deflation" that deflation would increase the burden of debt. It is because following a sequence of panic selling of assets, the asset prices fall. As the asset prices drop further, more distress-selling will be triggered. With a decrease in the velocity of money circulation, dumping of assets and distrust as well as hoarding will be possible and leading to a further plunge. Cases of bankruptcy and bank runs may be resulted.

No doubt, it is the government and our decision-makers' role that could put a stop to the potential deflationary cycle and avoid economic catastrophe developed in the near future.

* ---In the early last century, Fisher asserted the quantity theory of money in "The Purchasing Power of Money" as related to the equation of exchange, which holds that M the supply of money multiples its V the velocity of circulation (the rate that a currency circulates in the economy) is equal to P the general price level times Y the real output; MV=PY. He explained how the change in M, V and P could cause real output and real interest rate be changed to a new equilibrium position that may cause the booms and busts of the economy.

See also at http://wongtc.blogspot.com/2009/02/blog-post_21.html