The Global Financial Crisis and the Role of China Zhang Bin Introduction

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The Global Financial Crisis

and the Role of China
Zhang Bin


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


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

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.

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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,


The Global Financial Crisis and the Role of China

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

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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

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.

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