Department of Culture and Global Studies
Study Program: MA, China and International Relations
8th Semester Project Work
China’s Response to the 2008
Financial Crisis: How Can It Affect
U.S. – China Economic Relations?
Name: Evgeni Genev
Study Number: 20132337
Card Number: 113281
Supervisor: Peer Møller Christensen
Semester: SPRING 2014
Contents
INTRODUCTION ............................................................................. 1
METHODOLOGY ............................................................................ 3
THEORY: LIBERALISM ................................................................... 5
ANALYSIS....................................................................................... 9
The Impact of the Financial Crisis on China ................................ 9
The Chinese Response to the Financial Crisis ............................ 11
Impact of the Crisis to the US – China Economic Relationship ... 13
CONCLUSION .............................................................................. 18
BIBLIOGRAPHY ............................................................................ 19
INTRODUCTION
The effectiveness with which the People’s Republic of China has responded to the most
recent global financial crisis has earned very high marks from analysts and experts on the issue.
Since the country is not burdened with a huge debt, and it has staggering amounts of foreign
currency reserves, The People’s Republic managed to direct tremendous amounts of capital into
its economy, and in so doing stimulate productivity and overall growth. The Chines response has
been labeled swift and timely, managing to address a variety of economic imbalances most of
which had been dependent on foreign direct investment (FDI) and export. The stimulus package
consisting of three parts that will be discussed further in this paper, intended to focus on
domestic consumption, making an attempt to steer growth away from FDI and export
dependency. An economic model more reliant on domestic consumption and trade might prove
to bring about a more sustainable growth for the long term future. If the reforms are to be
implemented correctly, China might be in a better position after the crisis, than before it.
Nevertheless, existing tensions in terms of trade with the United States might escalate due
to the reforms. It will not be a mistake to state that the imposition of sanctions is quite plausible.
The stimulus package and China’s currency policy are labeled by many in the US as illegal, also
presenting the argument that most of the subsidies go to industries that produce goods that are
exported to the US market. There have been many calls for the US government to impose duties
on those goods so that the subsidies would be offset. The US has consistently made calls for
China to enable its currency to flow in accordance with the market conditions, rather than
remaining clanged to the dollar. However, if China is to comply with these calls, the price of
exports will increase in a time when the People’s Republic is trying to recover from the financial
downturn by increasing its exports. This currency issue puts additional pressure on the tense
trade between China and the US. The perspective on the Chinese side is that the US created the
mortgage problem that triggered the crisis and is now trying to disable China from taking the
necessary steps towards recovery. (Bulman, 2010)
In the aftermath of the global financial crisis the China – United States economic
relations are still unfolding. It is too early to make a prediction if the tensions are to evolve into
sanctions. What is quite evident, however, is the rising trend of protectionism on both sides. In a
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historical context, protectionist policies between trading partners do result in sanctions, and if
that is to be the case the results might be quite unfortunate for the US – China economic
relationship. Time will show if those two countries will be indulged in a trade war or if the more
moderate voices will manage to address the trade issues, avoiding drastic measures. (Chance,
2010)
This paper intends to address the potential escalation of trade tensions between the
United State of America and the People’s Republic of China, as a result of the Chines response
to the financial crisis of 2008. The paper is divided into four main parts. In the first part the
methodology of research will be explained, followed by the second part where a theoretical
approach will be adopted. The third part is the analysis and it will be subdivided into three. Here
the impact of the global financial crisis on China will be presented, the Chinese response to the
financial downturn will be analyzed, and the potential economic repercussions for the US –
China trade will be discussed. The final part of the paper will be the conclusion where an
overview of all said will be given.
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METHODOLOGY
Having in mind that the issue that this paper deals with is of tremendous contemporary
significance, the manner through which the research would be conducted is by using a second
hand analysis upon the subject. There has been an array of assumptions on the impact that the
international economic crisis has had on the United States and China. Both domestic and
international levels of analysis have been employed in order for the shift in the relationship
between those countries to be fully realized.
The theoretical approach that will be used in this paper is the one of liberalism. In that
regard first the variety of liberal approaches to international relations will be presented and their
focus explained in the theoretical part of this work. In doing so the reader will be acquainted with
the overall spirit of the analytical part of the work, thus achieving clarity and avoiding
unnecessary complexity within the overall framework of the text and the expressed views in it.
Since the issue itself is quite elaborate several dimensions would need to be presented and
discussed in the analytical part. Using the understanding of the different analytical levels, the
impact that the global financial crisis has had on China would be the first section of the
analytical part of the paper. Achieving a proper understanding upon the problems that have
arisen from the financial downturn is key, if the reader is to comprehend fully the rationale
behind the response of the country. The response to the financial crisis, on behalf of China,
would be presented in the second section of the analytical part. After the measures that the
Chinese government has taken are also explained the paper will continue by diving in the
examination of the impact that those measures might have on the economic relationship between
China and the United States. Finally a short summary of all that has been presented would be
made and based that a conclusion will be drawn.
The main sources and materials that are used for the acquisition of information are
published scholarly articles as well as academic books and a variety of national agencies reports
upon the issue at hand. These types of sources provide a variety of opinions expressed by a sum
of different parties both affected and not affected by the effects of the international financial
crisis, on both sides of the Pacific Ocean.
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However there are certain limitations to the work at hand. Since the general topic deals
with the response to the financial crisis on behalf of the Chinese, a majority of domestic issues
on behalf of the United States would not be presented in debt or discussed in length. The
relationship between both countries in the framework of the United Nations would also not be
mentioned, despite the fact that it can give a different angle upon the subject matter. Since the
liberal theoretical approach is quite elaborate, other major theoretical lenses such as Realism and
Marxism, would not be used for the examination of the issue.
4
THEORY: LIBERALISM
To begin with, we will take a look at liberalism. Along with socialism and conservatism,
liberalism emerged during the 17th and 18th centuries as a result of Enlightenment as well as the
political and industrial revolutions. Remaining true to the ideas perpetuated at the time of its
come about, liberalism believes in progress through the possibilities of improvement, which
would or is supposed to happen with developments in knowledge and morality. Despite the fact
that the confidence in some of those has been slowly disintegrating, liberalism is still considered
to be an ameliorate aspiration. Shaped by Enlightenment, the ideology of liberalism emphasizes
on equal human rights and individual liberty as the goals to be achieved. There is space left in
the theory that acknowledges the right of individuals to pursue their goals in ways they see fit.
The immediate problem which arises from that, however, is how to avoid the accumulation of
too much power by a fraction or an individual in a society in which people are free to do
whatever they want, in the way they see proper. To deal with that sort of a paradox the theory
tries to draw the line between the public and the private. In order to do that liberalism suggests
that the notions of political power and the power held in private everyday interactions need to be
described and differentiated from one another. To give an example, J. Locke distinguished
between the power that a husband and a father has over his wife and children, the power that a
master has over a slave, on one side, and the political power on the governance level, on other.
What came as a result from this examination was the understanding that political power is only
legit when it is consented. The body that the power has been consented to, is supposed to direct it
towards the public good, while being limited and controlled by settled and known law. In that
drain of thought this notion of limited governance becomes one of the main things that liberalism
is concerned with. In terms of economics, the ideology again urges state intervention to be
removed from the market, making the argument that a free-market economy generates more
prosperity and is more efficient, than a state controlled one. (Dunne, 2007)
All classical liberal theories of International Relations share the core assumption that
structures and actors on the domestic level strongly influence the interests and foreign-policy
identities of states and their behavior on the international political arena. In this theorizing of
identities, behavior and interests from the “inside out”, liberal approaches take into account
domestic properties, such as institutions, actors and practices, as the most significant explanatory
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variables. Seen through the “levels of analysis” used by Waltz to theorize international politics,
liberal theories of international relations are viewed as second image approaches. What is meant
by that is the explanation of outcomes on the international level through the level of the state.
However there is no single theory of “classical liberalism” in international relations. Rather there
is a variety of liberal approaches. All such second image approaches share the core assumption
that in order to explain the behavior of states on the international level, the domestic level needs
to be considered as a core variable. Some of the approaches take into account the domestic actor
and the interaction dynamics in the economic, social, and political spheres as the predominant
explanatory factors, whereas others put their focus on economic systems, political constitution
and dominant ideologies. All together liberal theories can be differentiated between two
dimensions: on one hand, approaches to action and interaction, and on the other hand, the choice
between agents and structures as ontological prior. (Dunne, 2007)
The first dimension is a distinction between constructivist and rationalist approaches.
Both rationalism and constructivism are not substantial theories of international relations, but
meta-theories resting in different assumptions on the constitution and nature of actors. In its core,
rationalism is based on methodological individualism. That fosters the assumption that the actor
is prior to and can be viewed independently of social structures. The interests of actors are
perceived as exogenously defined and stable throughout ventured interactions, and it is assumed
that human beings behave in accordance to a strategic rationality. Ends and means are carefully
calculated in order for the interest to be maximized. Strategies towards the pursuit of interests
can be changed, if new ideas on any constraints alter the calculations of the means-ends.
According to these assumptions, the nature of institutions is regulative in nature. They do not
shape the identities or interest of actors but do have an influence on the strategic choices and
enable, sanctions, or prevent certain actions. (Dunne, 2007)
Based on an ontological assumption, by contrast, social constructivism makes the point
that intersubjective meaning is constitutive for international actions. The actor is not the
ontological prior; rather the structure is mutually constitutive. Intersubjective meanings
constitute and influence the development and selection of an actor’s policy interests. They can be
created and changed by actions such as communication and diplomacy. The changing of the
intersubjective meaning is not taken as given, but it can rather shift during the process of action
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and interaction. Contrasting rationalism, constructivism, considers institutions not as regulative
but as constitutive in nature. Institutions influence the actor’s identity and policy interests.
The second dimension of distinguishing between the types of liberal approaches, relates
to the significance attributed to the variety of domestic features. Some liberal approaches tend to
be actor-centered and emphasize on domestic politics, while others put the emphasis on domestic
structures and the polity. Actor-centered approaches theorize the relevance of domestic politics
for the states foreign policy decisions. Through this perspective states are not to be viewed as
unitary actors with their interest determined by the nature of the international system. Rather the
interests of the states can vary in across time and policy, since they are shaped by beliefs,
identities and interests of groups on the domestic level. In accordance, actor-centered liberal
approaches analyze the interests of domestic groups and the process through which the pursuit of
those interests influence processes of national policy decision making. In pluralist regimes,
interests and beliefs of actor on the domestic level are most of the times conflicting on some
levels. Thus as a result the varieties of societal interest groups, such as trade unions, business
associations or domestic NGOs, compete for influence over the positions that the state assumes
on the international level. (Dunne, 2007)
Unlike the actor-centered approaches, structure-centered approaches put the focus on the
domestic polity, rather than the domestic politics. The fundamental assumption is that the manner
of interaction between the state and other states is not guided by the structure of the international
system, but strongly influenced by domestic structures, social, political, and economic
institutions. States are regarded as the most important actors in international affairs. However
they are not similar units whose behavior is the same in response to opportunities or international
pressures. Rather states are characterized by the properties of their polity that influences their
interaction with others. There are three structural dimensions: the political structure, economic
structure and social structure. Economic structures are the types of economic system, while the
social structure incorporates the shared convictions of truth, appropriateness and rightfulness.
(Dunne, 2007)
Put in a shorter and more comprehendible manner, liberalism is viewed as a political and
economic doctrine that stands for the limitation of government power in both society and
economics, operating under the assumption that humans are generally good and are capable of
being fair to one another thus enabling them to take care of their social interaction. Also putting a
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large emphasis on the rights and freedoms individuals have. An argument, worth mentioning,
made against the theory is that it is infested with bourgeois values, typical for the emerging
capitalist class in society. Given the usefulness of the liberal second image theorizing, and the
increasing interest in globalization and second image reversed inquiry, liberal international
theory focused on the examination of the nature of states and domestic politics, as well as their
interaction with international processes has proven to be of key significance for theorizing
international affairs.
8
ANALYSIS
The Impact of the Financial Crisis on China
As the 2008 financial crisis spilled from the developed countries to developing
economies and spread from the financial sector to the real economy, a variety of opinions and
assumptions about China and its economic future started to appear. Some state that the country
might be immune to the turmoil taking place in the West, due to its closed capital account and
insolated banking sector. Others state that with the reforms taking place in the last several
decades and its fast economic rise the country has become too intertwined with, and exposed to,
the risky western financial instruments.
Despite the fact that some of the statistical data regarding the impact of the crisis on
China might be misleading, some of the damage can be seen on the ground (real economy).
China’s export oriented light industry is one of the sectors that have experienced the global
stagnation. In the southern parts of the country many companies have gone bankrupt sending
millions of migrant workers back home to their respective provinces. The financial market in the
country has experienced setbacks immediately after the crisis, since many of the western partners
to the Chinese banks have pulled out selling their small stakes in order to retrieve capital. The
Chinese Investment Corporation (CIC) has also experienced losses due to its involvement with
western companies. For the first time since 2001, in November 2008 the exports fell with 2.2%
followed by 21% decline of imports in December. Beijing was forced to take measures. On the
domestic front the government focused on providing means to deal with the downturn of the
economy, so that the social cost of the crisis would be minimized. The goal of 9% growth was
set for the upcoming 2009. In order to ensure it, a stimulus package of 4 trillion Yuan (586
billion dollars) was issued. Many of the measures included investments in infrastructure and tax
rebates for the affected sectors of the economy. On the international front China has managed to
portray itself as a responsible power, not making commitments that might surpass its capabilities.
The country has made it clear that its biggest contribution to the global financial stability would
be to keep its own economy in check, ensuring a steady growth rate. (Moosa, 2012)
China’s economic growth has depended highly on FDI and export. While domestic
consumption is one of the major economic drivers in the US, in China it does not play that big of
a role. The Chinese economic logic is highly dependent on the country’s trading relations with
others, if it is to maintain a stable growth rate. As a result of the global financial crisis such trade
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relations have come under pressure. The country lacked exposure to the mortgage problems of
the west and it does place a number of restrictions on capital outflows to foreign shores. These
restrictions disable Chinese citizens from investing abroad, thus forcing them to invest in the
domestic real estate market, PRC banks and the Chinese stock market. The PRC government has
the mass of investments abroad, and it mostly consists of foreign currency reserves. However,
the PRC government invests mostly in instruments that are safe and low-yielding, much like the
US Treasury securities. In the summer of 2008 the Treasury Department of the United States
made an estimate that the total securities held by China equaled 1, 2 trillion dollars, whereas the
previous year it had $922 billion. China became second only to Japan in holding US Treasury
securities. (Mu, 2012)
While the exposure that the country had to the subprime mortgages was in fact limited,
the problem did have an effect on the China’s economy due to its harmful impact on the two
largest trading partners that the country has. The declining consumption in the US and the EU
slowed down the Chinese economy. China’s largest export targets appeared to have lost the
appetite that they previously possessed, and as a result of this economic downturn China’s
exports significantly declined. As multinational companies started cutting cost, the FDI inflows
also went down, since there was no spare capital for foreign investment. FDI inflow in 2008 was
over 70% while only one year later it went down to 22.5%. Both the decline in FDI investment
and the lower trade of merchandise put stress on the China’s economy. The GDP of the country
fell down to 6.6%, which might seem as steady at first, but it has to be taken in to account that
the country’s average growth per year, ever since the reforms of 1978, was one of around 10%.
Having in mind the speed of the population growth, and the fact that the country has to create
approximately 20 million jobs every year, many economists speculate that for China to be stable
the GDP needs to maintain an average of at least 8%. (Morrison, 2009)
Other effects of the global financial crisis can be witnessed in the slowing down of the
real estate market. In many Chinese cities construction of new buildings has slowed down
because of a drop in the prices, leaving a lot of buildings unfinished and uninhabited. The decline
of the Shanghai Stock Exchange Composite Index is another indicator for the overall health of
the economy and the effect of the financial crisis.
All together the factors mentioned above, with special attention to the ability to create
new jobs and the loss of already created ones, could prove to be a force for serious social turmoil
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in China. A large majority of the Chinese population is still under the poverty line according to
international standards. The source of support for the Communist Party of China has been rooted
in its ability to deliver prosperity through economic growth. If the CPC does not manage to
continue this manner of behavior, then it would be safe to say that its authority might come into
question.
The Chinese Response to the Financial Crisis
The millions of workers who lost their jobs in the export sector as well as the damage to
the GDP have increased the demand for a faster implementation of the already planned rebalancing of the Chinese economy. According to the 12th Five Year Plan, for the economy to
continue flourishing in the upcoming decades a more sustainable model needs to be adopted.
A fact in the matter is that the Chinese economy has the potential to become more like
the one of Japan or the United States. Both countries are amongst the largest traders in the world,
but the most fundamental drivers of their growth are the domestic consumption. It was in the
1990s that China came as close as it has ever been to resembling them. However with the
tremendous success of the “open door” policy, China has gone to become more like Germany
where in 2007, 76% of the GDP consisted of export revenue. Nonetheless, when the financial
crisis hit, it took its toll on German, Japanese and US economies with akin severity. In China’s
case, despite the effects mentioned above, the government managed to reduce many of the
potential hazards with the swift implementation of stimulus for the monetary and fiscal sectors,
resulting in a significant increase in the domestic demand. Because of this, China has now
realized that by strengthening both external and internal demand it can reduce its exposure to
global economic downturns. By increasing the portion of growth fueled by domestic demand and
expanding its trade China can restructure the economy so that it will allow it to benefit from its
involvement in the global economy while maintaining a large base of demand at home, which
can shield it from external shocks. This reorientation, however, means that the saving tendencies
of households and firms in China need to be addressed. Consumption in China has fallen from
50% in the 1980s to one third by the late 2000s. The precautionary savings motives of Chinese
citizens, especially in the rural areas need to be changed. This means that the country needs to
focus on investments in social security provisions. The 2009 stimulus plan did contain some
measures but a lot more is needed. Jobs on all ends of the skill spectrum need to be created, and a
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sustainable urbanization of rural areas has to be maintained. As a result rural residents’
consumption potential can be increased. (Bulman, 2010)
The financial system in China is primarily based on state owned enterprises, which make
it difficult for private firms to obtain credit, from banks or the domestic capital market. Because
of this, in order to ensure growth firms depend heavily on retained earnings. Within this
framework, policy reforms need to focus on increasing the aggregate demand, reduce the rate of
savings on both households and firms, so that higher outputs in a context of less trade surplus can
be guaranteed. Government investments in support of private incomes and capital market
efficiency can also bring about higher consumption rates. What is central in addressing the
savings issue is the lagging wages and low income growth in households and for firms, as well as
the reformation of the capital market. Since the 1980s the annual industrial output has grown at
14.1% on average while the wage growth has lacked the same pace. In less developed rural areas
income conditions are the worst. It is because of this imbalance between the labor income and
the industrial output, that saving has become a major incentive in ensuring a stable future, but
has lowered consumptions’ share in the country’s GDP. If wage growth is increased to match the
marginal labor output, the higher wages would prompt growth in productivity that can eventually
match any salary increase thus rising incomes and boosting consumption. (Chance, 2010)
Additionally, the removal of restrictions on mobility, allowing migrant workers to settle
in urban areas, increasing the momentum of urbanization can lower the labor market stagnation.
That would mean for geography and the hukou to become less of a barrier for workers searching
for a job that matches their skills. With an increase in urbanization the government would need
to focus on investing and providing equal social services like pensions, health care, education
and unemployment benefits. With an adequate social security plan, an ongoing urbanization and
a bit more freedom of the market the domestic consumption is bound to grow.
China has the ability to become a large and fast growing open economy – developing
domestic demand and transforming its industry. Having in mind that the country’s development
is still considered low, its integration to the global markets benefits the world as well as China.
However, in order for the country to assume an optimal position in the global economy, many
reforms would need to be made. The country might have achieved the extraordinary for the last
30 years but there is still a considerable amount of “caching up” to be done. Imbalances have
always existed, however, with the worst financial crisis in a century just having passed, China
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will have to re-balance its economy if it is to sustain its growth, which until now was mainly
export driven.
Impact of the Crisis to the US – China Economic Relationship
The nature of the US – China economic relationship has severe implications on the
functioning global financial system and trade. With the flow of goods, people and capital those
two dominant economies are becoming more and more integrated with one another. All the
emerging complex linkages have started to spread beyond trade and finance to issues such as
global security and political dominance. It is because of this spillover effect, the relationship
between both countries is of considerable importance. In the aftermath of the global financial
crisis this relationship has been put on the hot spot of international attention. It is safe to say that
China and the US are an embodiment of the imbalance of the global macro economy. Despite the
fact that the US and its policies are mostly to blame for the initiation of the financial downturn, it
is somewhat ironic that the Chinese savings tendencies, the management of its currency and the
high production of cheap goods, for the US market, set the stage for the severity of the events,
making them a crisis of cataclysmic proportions rather than a manageable financial bubble. As a
consequence, China has also experienced the crisis but more in the lines of a rebound rather than
direct downfall. (Morrison, 2009)
Nevertheless, both economies are bound to tighten their grip on one another, at least on
the short-term. At present China needs to continue its export growth if it is to preserve the social
balance that it has been striving for. With the continuation of exports towards US and EU
markets, the country does not have a lot of options in using its surpluses, rather than buying US
treasuries. The US itself needs consistent buyers of its treasuries so that it would manage the
budget deficit, which is increasing with the recent fiscal stimulation and the issued bailouts. This
unhealthy relationship has intensified since each partner sees the other as having a bigger benefit.
As the aftershock of the global economic crumbling is passing over the rest of the global
economic players, many seek to isolate themselves as much as possible, using protectionist
approaches, thus putting more tension on this already intense relationship.
A flash point for those tensions has become Chinas policy towards the exchange rate.
With the trade deficit between China and the US swelling up tremendously during the recent
years, many accusations in regards to currency manipulation have been revived. Many in the US
have called for the legislative branch to impose duties and tariffs on Chinese imports, as
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precautionary measure against a failure in the exchange rate reform. At the same time,
protectionist policies such as the “Buy American” clause in the stimulus bill are backfiring since
they affect not only Chinese imports but imports from other markets as well, and are being
interpreted as a show of the rising trade tensions. However, an approach of confrontation is
bound to be unproductive. Any form of aggression on any side would have profound negative
effects on many fronts of the China – US relationship. Furthermore, an approach of threats and
sanctions would make matters worse for all of the global economic players creating a period of
instability in the world economy. (Nathan, 2012)
What is fundamental for the China – US relationship is the commonality of their
interests. If a mutually beneficial economic relationship is to exist, then it would be the shared
interest that would be the ones to foster it.
Despite everything trade between both countries is continuing to flourish and the US is
still China’s biggest market for export. Chinese exports have risen from 100 billion dollars in
2000 to 338 billion dollars in 2008, and Chinese imports from 16 billion to 71 billion,
respectively. What is intriguing is that the share of exports going to the US has experienced a
minor drop from 22% in 2000 to 19% in 2007, but nonetheless the bilateral trade surplus for
China has continued its rise form 84 billion dollars in 2000 to almost 266 billion dollars in 2008.
The financial flows between both economies have risen as well. The bilateral foreign direct
investments form the US to China have declined dramatically from 5.4 billion dollars in 2002 to
2.7 billion dollars in 2007, whereas in contrast the FDI flow from China to the US has been
gaining increasing momentum. This is mostly reflected by the Chinese central bank and its
purchasing of US treasury bonds. Despite the fact that precise figures are hard to come by, the
estimate made by the US Treasury is that China held about 700 billion dollars of US treasury
securities at the end of 2008. What will happen to the nature of the ties between the US and
China depends highly on the severity of the measures taken by both of the economies to pull
themselves out of the global financial downturn. Regardless, there has been an issue that has
been casting a shadow over the relationship and is defining the level of their engagement. (Mu,
2012)
The problem with the exchange rate has been a subject of many discussions about the
China – US economic relationship, seemingly framing it within the boundaries of the bilateral
trade balance between both. China has been accused of implementing protectionist policies by
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keeping the exchange rate of its currency undervalued, thus gaining competitive advantage in the
global market. However the country has allowed the renminbi (yuan) to rise with 21% relative to
the US dollar, since 2005, thus lessening the strength of this argument. Regardless, however the
country has continued to accumulate foreign exchange reserves, which can be interpreted as an
intervention on behalf of the Chinese central bank in the exchange market. Even some IMF
senior officials have stated that the renminbi’s value is significantly under what it actually should
be.
Leaving aside the exchange rate, which is the most visible symbol of the policy towards
trade implemented by China, there are other forms of protectionism that also deserve attention.
One such is the financial system in the country, which consists mainly of state owned banks that
provide cheap capital to the enterprises operating in the country. Many of the subsidies to energy
and land have lowered the costs of production and capital. This gives manufacturers in China a
significant advantage, in terms of costs, and gives them the ability to be highly competitive in the
international market. But on this front the US has lost its ability to take a higher ground since it
has also recently introduced subsidies to its own financial sector and some industries.
The debate about the China’s currency is framed in a way that missies the broader
context of the situation. An independent monetary policy is essential if the country is to maintain
objectives on the home front, such as growth and low inflation. A flexible currency can be
considered not as an objective but a prerequisite if domestic issues are to be addressed
adequately. Freeing the Chinese central bank form the target exchange rate, giving it freedom to
lower or raise interests would result in a deterrence form unhealthy investment, and risk
reduction from boom-bust cycles. It has to be said that an independent monetary policy requires
for the exchange rate to be flexible, rather than increasing the value of the currency at once or
even gradually. For a reform in the financial sector to be successful an independent monetary
policy is of key significance. To make the banks stronger financial institutions, credit expansion
would need to be guided by interest rate policies instead of government directives. If such
policies are not adopted the central bank will have to maintain its practice of giving instructions
on who can take loans and how much is to be lend, which removes the incentive for banks to
maintain an adequate assessment and price risk analysis, disabling them from behaving like
commercial entities. By not giving state-owned banks any choice but to buy bonds from the
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central bank, it is easier for the central bank to “sanitize” its foreign exchange market
intervention, thus keeping the money supply at home under control. (Guo, 2010)
In order to further consider the economic relationship between China and the US it is of
great importance to examine it in a global context. In order to achieve this, the question of: Has
the relationship between both fomented the international financial crisis? (as suggested by some
observers) needs to be examined.
The debate about whether the global economic downturn was a result of the
macroeconomic inequalities is still ongoing. Many of the imbalances are characterized by the
increasing account deficits in many industrial economies and mostly the US, where these deficits
are financed by savings in emerging market economies such as China. The savings alongside the
profits of oil exporting countries were introduced to the US financial market since the countries
that enjoyed the surplus lacked functioning financial systems that could produce adequate
domestic investment. The tremendous amounts of inflow paved the way for a long period of low
interest rates in the US and disabled economic mechanisms for self-correction, such as the rise of
interest initiated by the low rate of saving and the high rate of government borrowing. Regardless
of the opinions about the significance of the imbalances against the domestic problems in the US
financial system, in relation to triggering the crisis, it cannot be argued that the inequalities did in
fact faster the triggering of the cataclysm. What needs to be mentioned is that the policies that
allowed for inequalities to appear in the first place were not in the long-term beneficial for any of
the concerned states. Over the short term all of the existing inequalities have the potential of
worsening the macroeconomic problems of the main global economies possibly paving the way
for a second global economic crunch. (Cabestan, 2012)
There is a great set of ironies in the way the global financial crisis has played out. The
macroeconomic imbalances have most certainly not unraveled the way it has been predicted by
economists. Instead of an adjustment through the value of the dollar, the account deficit of the
US might adjust only by a significant decline in domestic consumption. The US itself has turned
into a place that is relatively safe financially with the flight of its treasury bonds. Most emerging
markets seem to be rethinking the notions of what is an adequate size for a reserve, thus
preparing to build up even larger stocks of reserves. As the global economy is pulling out of the
crisis the imbalances that were a cause of many of the problems could potentially intensify
instead of disappear. It is because of that, solutions would require global action rather than
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individual. Despite the fact that a lot has been said about the redesign of financial regulations, all
needs to be supported by clear macroeconomic policies. (Morrison, 2009)
Continued levels of engagement between the economies of China and the US need to be
on top of the priority lists of both governments. Strategic economic dialogs can be a useful tool
in fostering this relationship. The high-level dialogs can raise the trust and awareness of the
domestic factors acting as drivers of decision making on both sides. Both countries have
complex domestic dynamic that appears to be uncomprehendable for many outsiders. Pressures
coming from the outside can help the reform processes taking place, if they are situated in the
right place. For example, the exchange rate debate has become more political rather than being
placed in the context of the China – US trade balance. The international community can help by
reorienting the discussion in a way that would bring a clearer focus on the linkages between the
reforms in the currency and the rest of the reforms, where there is a broad consensus with China.
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CONCLUSION
With no exposure to the subprime mortgage assets, as well as its significant reserves in
foreign currency, The People’s Republic of China has managed to withstand the effects of the
2008 financial crisis better than the rest of the major trade players in the world. The most
significant impact that the crisis has had on China was the lower demand for export and the
decrease in the influx of foreign capital. The implemented reform package, targets to deal with
those issues by maintaining exports on the short-term, so that jobs will not be lost and factories
will not have to close. On the long-run, the economy is to be rebalanced so that it is not so
dependent on FDI and export for growth. Tactics of pressure on behalf of the United States, for
China to make changes to some internal policies might be viewed as an attempt to undermine
China’s economic recovery. Threat of trade sanctions are not a pleasant prospect for China.
Having in mind the still unstable economy conditions in the country it is very likely that China
will be willing to have a hostile response. Despite that many hardliners in the United States are
calling for additional duties so that China’s currency subsidies can be contravened. If the
protectionist tendencies on both sides take root, then trade sanctions on one side will lead to
trade sanctions on the other and that might eventually result in to a trade war. A moderate
position on both sides is to be based on diplomacy and dialogue with no threats and
recriminations. Such a moderate approach would seek low but persistent changes in Chinas
economic policies both on the domestic and international levels. A no hostile call for further
gradual reform might resolve most of the present trade issues without escalating the tensions
between both countries. (Zicheng, 2010)
Maintaining a high-level avenue of dialog could be beneficial for building awareness and
trust of the variety of constraints and politics driving decision making on both sides. There are
complex internal political dynamics on both sides. In China as well as the United States there are
a multitude of political fractions that find themselves at odds on matters of economic politics.
Influencing the responsible people, in both countries, and helping them influence others is as
important as the substance of the message itself.
As far as China’s reforms are concerned, ultimately, there is a variety of shared interests
among policy makers in China and the United States. Sustained and balanced growth is to be
promoted by a deep and enduring reforms, all of which is in the best interest not only of China
and the United States but the world as well.
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