The Global Financial Crisis
and the Role of China
Zhang Bin
Introduction
The subprime mortgage crisis that started in July 2007 in the US evolved into
a global financial crisis in 2008, which has seriously hurt the global real economy
and has caused the most severe economic recession since the Great Depression
in 1930s. Although many countries have taken various packages of combating
actions, the financial crisis continues to worsen in 2009. The prospects the world
gets out of the financial crisis and economic recession is still highly uncertain.
As the largest developing economy in the world, China is also affected by the
crisis. However, with its huge economic strength accumulated in past 30 years,
Chinese government has promptly adopted flexible combinations of economic
policies aiming at expanding domestic demand and maintaining steady growth.
It is hopeful that Chinese economy could recover quickly and continue to play
the role as one of the engines in the world economy.
Effects and Causes
After the overall unfolding of the global financial crisis in September 2009,
the stock markets worldwide crashed almost simultaneously and entered a period
of high volatility. In the US, a considerable number of banks, mortgage lenders
and insurance companies went to bankruptcy in the following weeks. Real sectors
of the world economy have been gradually affected by the crisis and have fallen
into the worst recession since the end of WW II.
Many indicators of world economy are worsening. First, the volume of world
trade is substantially shrinking in 2009. According to Global Economic Prospects
issued by the World Bank on March 30, world trade in goods and services is
expected to fall 6.1 percent in 2009, a historic decline.
Dr. Zhang Bin, Associate Research Fellow, China Institute of International Studies
338.124.4:336.7(510)
Second, world unemployment is sharply increasing in 2009. According to
the International Labor Organization, two years of global financial and economic
meltdown could leave over 50 million more people unemployed by the end of
2009. And because of the financial crisis, business bankruptcy and dismiss, there
will be over 20 million job losses globally, mainly in the sectors of building,
real estate, financial services and auto industry. This would cause the world
unemployment number to rise to the record high of 200 million by the end of
2009.1
Third, mainly because of the worldwide economic uncertainty and speculative
forces, prices of international bulk commodities, particularly the oil price, soared
and collapsed like roller coaster in 2008. In January 2008, the oil price surpassed
100 US dollar for the first time in history. In July 2008, it reached a record high
of 147 US dollar. However, in December 2008, the oil price sharply fell below
35 US dollar. And in June 2009, it bounced back to about 70 US dollar. The
roller-coastering of oil price and prices of other international bulk commodities
has constituted a great shock to the world economy. Some countries that depend
heavily on oil economy have suffered grave stagflation.
Fourth, most countries and regions in the world have got mired into
economic recession. Since the fourth quarter of 2008, virtually all economies –
both the industrialized countries and the emerging markets – have undergone
synchronized negative business cycles. The year 2008 can be called the bankruptcy
year for the United States, for it underwent the gravest bankruptcies and financial
crisis ever since the end of WW II. A recession is defined as a period of two
quarters of negative GDP growth. In December 2008, the NBER declared that
the United States had been in recession since December 2007. Denmark was the
first European economy to confirm it is in recession since the global credit crunch
began. Germany, the Europe’s largest economy, fell in recession for the first time
in five years in the third quarter of 2008. As a whole, the Euro Zone officially
went into its first recession in 2008 since its creation in 1999. Japan, the world’s
second largest economy, fell into recession in the third quarter of 2008 for the
first time in seven years.
Although sometimes there may appear some improvements (green shoots
as called in the US) in some economic indicators in the US financial markets,
real estate markets and auto industry, the prospects of overall world economy
remain highly uncertain. On February 18, 2009, the US Federal Reserve cut
their economic forecast of 2009, expecting the US output to shrink between
0.5% and 1.5%. The EU commission predicted on January 19, 2009 that the 27
EU countries will contract -1.8% on average this year. On April 22, 2009, the
1
ILO ’s report, Global Employment Trends 2009.
– Zhang Bin –
German government predicted a decrease of the German GDP of at least -5%.
As global economy deteriorates, on June 22, the World Bank predicts a sharply
slower global growth for 2009, -2.9%, much lower than -1.7% prediction made
in March this year.
What are the primary causes for the worst global financial crisis and recession
ever since the Great Depression in 1930s?
First, to a large extent, it is because of purely US domestic problems. These
problems include: the over-developed financial industry in the US, the lack of
financial supervision, and over-consumption. In today’s US economy, while
most industries have been contracting, the financial industry has been expanding
gradually. According to US official statistics, in 2007, 20.4% of total value added
to the US GDP came from the finance/insurance/real estate industry. While
in 1980, the figure was only 15.9%.2 The expanding US financial industry is
becoming completely different from its traditional image. Its focus has shifted
from its traditional role of supporting trade and real investment to a system rife
with speculation and financial gambling, to a system no longer managing genuine
economic risks but one actually creating and assuming financial risks. The financial
liberalization and innovation also meant that financial institutions were able to sell
loans or take them off the balance sheet, which weakened lenders’ incentives to
conduct prudent screening and constant monitoring of credit risk. Critics in the
US claim that former Federal Reserve Board Chairman Alan Greenspan, Treasury
Secretary Robert Rubin, and SEC Chairman Arthur Levitt vehemently opposed
any regulation of financial instruments known as derivatives. Deregulation
efforts have contributed to the proliferation of the complex and opaque financial
instruments which are at the heart of the crisis. Ultimately, it was the collapse of
a specific kind of derivative, the mortgage-backed security, which triggered the
current financial crisis.
The US Federal Reserve’s expansionary monetary policy is another primary
cause of the crisis. The Fed kept interest rates very low for a long period of
time to blunt the recession of the early 2000s. Some economists claim that the
ultimate point of origin of the great financial crisis of 2007-2009 could be traced
back to an extremely indebted US economy. The resulting malinvestment and
overconsumption of investors and consumers prompted the development of a
housing bubble that ultimately burst, precipitating the financial crisis.
Third, the current international monetary system with the US dollar as the
core causes the financial crisis quickly spread globally. There exist the fundamental
flaws in the current international monetary system. It excessively depends on one
sovereign currency, the US dollar, for quite a long period of time. In the system,
http://www.bea.gov/industry/index.htm
The Global Financial Crisis and the Role of China
2
the US dollar is the most important currency used as the unit of account and
means of settlements in international trade and is the main international reserve
currency. According to IMF statistics, by the end of 2007, US dollar accounts for
63.9% in global international reserves. For the United States as the international
key currency issuer, its domestic monetary policy goals often contradict with the
requirements for reserve currency by international community. US monetary
authority cannot concentrate its attention purely on domestic economic goals
and cannot ignore the international function of its domestic currency. It cannot
give full consideration to both the domestic and external goals of macroeconomic
policies. Actually, on the one hand, it is possible that the efforts to control domestic
inflation by US monetary authority will ignore the growing need for international
currency. On the other hand, it is also possible that the efforts to stimulate
domestic demand may lead to a glut of international liquidity. This is the so-called
Triffin Dilemma and it has existed in the postwar international monetary system
for quite a long time. After the collapse of the Bretton Woods system, financial
crisis occur increasingly frequent and intense. The crux lies in that the Triffin
Dilemma has not been solved by the international community.
Responses and Actions
In order to overcome the economic recession and the financial crisis, the
most urgent tasks for the international community are to strengthen global
consultations and cooperation, to adopt stimulating measures to restore economic
growth, and to stabilize financial markets and strengthen financial regulation. In
the meantime, it is also necessary to oppose any forms of protectionisms in trade
and investments.
After the financial crash in September 2008, China, the US , Japan and
the EU, all have announced economic stimulating plans, and are designing and
proposing other new stimulus plans. In October 2008, the US Congress passed
the the Emergency Economic Stabilization Act of 2008 that includes a financial
bailout plan of US$700 billion. The US, EU countries and India are implementing
or plan to implement rescue plans to enterprises in bankruptcy or on the brink of
bankruptcy. For important industries such as automobile, some countries already
carried out huge emergency rescue plans. In June 2009, Obama Administration
has put forward a plan for US financial regulatory reform.
For the sake of justice and fairness, developed countries should take the
primary responsibility in restoring global economic growth and stabilizing financial
markets. Developed countries assume a dominant position in world economy and
politics and have been profiting from the unfair trade with developing countries
– Zhang Bin –
by making use of this advantage. Therefore, developed countries should be
responsible for this unjust international political and economic order, particularly
when crises occur.
For the United States, the US government should observe stricter monetary
and fiscal disciplines, strengthen financial regulation and increase exports. The US
government should correct many fundamental disequilibria in domestic economy,
such as huge federal debts and fiscal deficits, national under-saving and irrational
industrial structure. It should be particularly pointed out that, in order to expand
exports and decrease the huge trade deficits, the US government should discard
those obsolete, restrictive and discriminative trade policies which are handed down
from the cold war age.
Internationally, countries in the world have been enhancing coordination of
macroeconomic policies. The G-20 consisting of major economies in the world
has become the new central stage of managing the global economic and financial
crisis. The G-20 has been a good place of dialogue between the developed countries
and the developing countries. Since the economic strength of emerging economies
is increasing, the influence of the G-20 will continue to expand. So far, the
G-20 had held two summit meeting on the financial crisis, the Washington and
London summit meetings, and has achieved fruitful results better than expected.
This year and next year, economic stimulus plans are especially important for the
international community to overcome the financial crisis. This kind of plans will
greatly improve confidence to restore economic growth. The following task is to
promote the effective and all-around implementation of the agreements achieved
at the G-20 summits.
The developing countries are the weak party in the world but assume the main
responsibility of eradicating human poverty. It is no surprise that they are more
seriously harmed by the financial crisis. Therefore, any actions and results should
take full consideration of the interests of developing countries, and be conducive
to the economic development of them, particularly the least developed countries.
Instead of protectionism, the developed countries should open their markets to
developing countries. In order to minimize the harms brought by the crisis, the
developed countries should effectively fulfill their promises and commitments of
aid and debt reduction to the developing countries.
While countries are designing and proposing economic stimulus plans to
recover domestic economy, it is especially important to be vigilant against any
forms of protectionism and contain their spread. Otherwise, protectionism would
offset our efforts and nullify the economic stimulus plans.
In the long run, for the sake of sustained and stable functioning of the
international economic and financial orders, it is imperatively important to
The Global Financial Crisis and the Role of China
enhance global financial supervision, to reform the international financial regime,
and to strengthen the role and functions of the International Monetary Fund.
Among the agendas, the most important are as follows:
First, reduce the use of the US dollar and change the dollar hegemony,
diversify international reserve currencies, and increase the use of the SDRs and
other settlement means.
Second, increase the say and decision-making power of developing countries,
especially the emerging economies, in international financial institutions.
Third, strengthen the supervision by the IMF on the macroeconomic
policies of major reserve currency issuing countries, reinforce the monitoring of
international capital flow, and promote the stabilization of the exchange rates of
key reserve currencies.
The ultimate and ideal goal for the reform of international monetary regime
is to create a super-sovereign reserve currency, which shall maintain persistently
stable value, de-link to any sovereign state and avoid the intrinsic defects of a
sovereign fiduciary currency. In addition to avoiding inherent risks of a sovereign
fiduciary currency, it could also serve as a valve and make it possible to regulate
global liquidity.
Without doubt, the reform of international monetary system is a gradual
and long process. In the foreseeable future, the US dollar continues to be the most
important international reserve currency.
The Role of China
Chinese economy is now comprehensively and deeply integrated into the
world economy. China is the third largest economy and the third largest trading
nation in the world. It holds about two trillion US dollar foreign exchange
reserves. And it is also the largest emerging economy in the world. It can be
said that China has been playing an active and constructive role in the current
international regime. However, the current financial crisis has also brought the
biggest and gravest challenges to the Chinese economy ever since China’s reform
and opening to the world in 1978. In recent two years, China’s exports have sharply
decreased, domestic unemployment is greatly increasing, economic growth has
significantly slowed, and state-owned foreign exchange reserves are facing the
danger of depreciation.
Undoubtedly, with its huge foreign exchange reserves and good fiscal strength,
China is better positioned than any other countries in withstanding the financial
crisis. There is much room for the Chinese government to stimulate economy.
Quickly responding to the shocks of the crisis and for the purpose of maintaining
– Zhang Bin –
smooth and rapid growth, the Chinese government has adopted the combination
of proactive fiscal policy and moderately loose monetary policy. In order to further
expand domestic demand, a package of plans had also taken shape in the fourth
quarter of last year. It mainly includes:
First, launch the four trillion yuan ($585 billion) stimulus plan to increase
investments in five domains, including projects in rural areas, housing projects
for social security, infrastructures such as traffic and transportation, energy-saving
and emission-reducing projects, and projects in social causes.
Second, launch the revitalization program for the top ten priority industries
and increase policy support for enterprises. The top ten priority industries for
revitalization are: light industry, automotive industry, iron and steel, textile,
equipment manufacturing, shipbuilding, petrochemicals, non-ferrous metals,
electronics and information and logistics. The aim of the revitalization program
is to halt and reverse the quick decline of industrial growth.
Third, increase financial support for economic development. Since September
2008, the central bank of China has lowered benchmark interest rates five times
and deposit reserve ratio four times, aiming at maintaining adequate liquidity
in the banking system and promoting the steady growth of money supply and
credit.
Fourth, focus on promoting employment and improving people’s livelihood,
increase subsidies and concessions to agriculture and farmers, thereby aiming at
expanding domestic consumer demand.
Fifth, promote the transformation of value-added tax and oil tax and other
key reform areas and crucial links in the medical and health institutions.
In the international arena, in conformity with a responsible attitude, China
has strengthened cooperation and coordination with international community and
has made positive contributions to stabilize the global economy and finance.
Despite of enormous difficulties, China has kept RMB exchange rate basically
stable, signed bilateral currency swap agreements amounting to 650 billion yuan
with the relevant countries and regions, actively participates in IFC trade finance
program, and has afforded support to the capital (quota) increase program of the
International Monetary Fund.
China is now the largest overseas holders of U.S. treasury bill and bonds. Data
of the U.S. Treasury Department show that, by the end of April 2009, China’s
holdings of U.S. Treasury bonds amounted to 763.5 billion U.S. dollars, a sharp
increase of 261.5 billion U.S. dollars compared with the figure of April 2008.
Because U.S. government bonds are guaranteed by the U.S. government’s credit
and revenue, its credit rating is relatively high and it remains a good investment
channel for China. The facts can not be changed in a short period that China
The Global Financial Crisis and the Role of China
will hold increasing amount of foreign exchange reserves and that the US dollardenominated
assets will maintain its strong international status. Therefore, it is an established trend that China
will increase its holdings of U.S. treasury bonds.
However, the current dollar policy adopted by the US can be characterized as a
dollar depreciating (weak dollar) policy. This constitutes a serious concern for
China and other developing countries. Thus, it is understandable that sometimes
China may reduce a certain amount of U.S. dollar assets.
At this crucial moment of the crisis and as one of the world’s largest trading
nation, China resolutely opposes any forms of trade protectionism and protective
measures. Together with other countries, China strives to maintain an orderly
and normal international flow of goods, services and personnel, and promotes
the Doha Round negotiations to achieve comprehensive and balanced results at
an early date.
However, China’s per capita income is still far lower than that of developed
countries. Its domestic infrastructure is still backward; there exists uneven regional
development in China’s domestic economy; and the domestic market economic
system is still not perfect. Therefore, China’s role in overcoming the global financial
crisis and economic recession is limited and is subject to the indisputable fact that
China is still a developing country. Reasonably, Chinese government must focus
its main attention on developing its own national economy.
Overall, the Chinese government’s policy response and measures to the
financial crisis are timely, decisive and strong. By now, the macro-control policies
and measures are beginning to bear fruit. There are good signs for some leading
economic indicators and the rapid decline in economic growth has been halted.
It is possible that the Chinese economy achieves 7-8% growth this year.
Although the adverse impacts of the international financial crisis on Chinese
economy continues to appear, the long-term good trend of China’s economic
development has not been changed. The stable and rapid development of Chinese
economy will have a positive impact on the world economy and can ease and offset
the adverse effects of economic recession in western countries on the economic
growth of the world. Despite the financial crisis, China continues to play the role
of engine in stimulating the world economy.