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Special> G20 London Summit> Expert's View
UPDATED: October 21, 2008 NO. 43 OCT. 23, 2008
OBSERVER China's Economic Readjustment
 
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Domestic economists are increasingly worried about the contingencies of the global financial crisis in China. Compared to their counterparts, China's financial institutions have remained relatively intact, because the country's financial system is less integrated in the global markets. Still, the damages on the mainland cannot be ignored. In an essay that was published in the China Securities Journal recently, Ba Shusong, Deputy Director of the Financial Research Institute of Development Research Center under the State Council, gave his assessment of the country's current status amid the global financial turmoil and offered suggestions on how China could weather the storm. The entire article follows:
 

The disastrous financial crisis this time might be a wrap-up of the oil crisis in the 1970s, the global economic readjustment in 1990-91, and the bursting of the dot-com bubble in 2001. The U.S. financial system is now undergoing a "de-leveraging" period after years of pursuing extreme leverage for extreme gains.

Domestic enterprises should be fully prepared for the U.S. economic downturn in the long run, the collapse of the traditional Wall Street investment banking system, and prolonged global financial turmoil caused by the depreciation of the U.S. dollar.

In the past few years, the global economy, characterized by high growth and low inflation, has been endowed with globalization, big progress in information technology and a peaceful global environment. But now, the effects of these factors on propelling economic growth are diminishing. The current financial turmoil might trigger a huge wave of anti-globalization sentiment.

The Chinese economy is integrating itself into the world economic system. Therefore, we should take a global view of China's economic and financial system adjustments to avoid falling into blind worship of globalization or ultra-nationalism. The ballooning debt and huge trade deficit of the United States are, to some extent, related to China's enormous foreign reserves and trade surplus. As a result, China should voluntarily readjust the current growth mode to prevent such global financial chaos from taking place again.

Derivatives' impact

People tend to blame financial derivatives for causing all the troubles. As a matter of fact, the basic functions of financial derivatives such as hedging risks and discovering value are still effective. The problem is that those derivatives lack transparency and a comprehensive information disclosure system. In addition, the supervision of those derivatives is less strict than for regular financial products.

The outbreak of the U.S. subprime mortgage crisis ignited fears about stock index futures, which reportedly will be offered soon on the mainland. In fact, stock index futures are a concentrated trading product on the stock exchanges and are different from subprime-related financial products. To date, most of the stock index futures exchanges in the world have set up standard and comprehensive risk management systems, including price-cap systems, deposit systems, market-to-market systems, compulsory stop-out systems, position-holding quotas and large position-reporting systems.

The financial turmoil caused by the subprime mortgage crisis could serve as a good lesson and a precaution for China in the process of developing a financial derivatives market, but it should not be seen as an obstruction to our development. We should learn from the U.S. lessons, and make full preparations in terms of designing derivative products and their related rules and regulations and educating investors. For instance, financial derivatives require investors to have professional trading knowledge, and not everyone has it. The government should create strict requirements for stock index futures traders so as to bring the new product into full play.

Minimizing losses

Internationally, the U.S. economic and financial systems have been propped up by increasing amounts of leverage that have created an enormous bubble, but now they face a "de-leveraging" period and must reduce their debt ratios. Therefore, Chinese enterprises should get ready for the prolonged economic recession in the United States as well as other repercussions triggered by the credit crunch.

The economies of developed countries will undergo a period of readjustment, which provides China with both opportunities and challenges.

China's unique strength might enhance its economic growth. In addition to vast domestic demand, China's integrated national strength is the greatest since the country was founded in 1949. Strong financial support can guarantee a series of tax-reduction measures and infrastructure investment. China has abundant foreign reserves, although its currency is facing appreciation pressure. The debt ratio of Chinese citizens and companies is low, leaving enough room to raise leverage. Meanwhile, international markets are beginning to recognize the value of the renminbi, thus laying a solid foundation for renminbi internationalization.

The above-mentioned factors could enable China to weather this round of the financial storm, but most importantly, the government should make good use of those favorable conditions while adopting macro-control measures.

The ongoing global economic recession is a combined version of the oil crisis in the 1970s, the global economic readjustment in 1990-91, and the bursting of the dot-com bubble in 2001. If we take a look at U.S. housing prices over the last 100 years, we see they remained unchanged during the first 90 years. But they jumped substantially in the most recent seven to eight years. As a result, this property bubble is one of the biggest in U.S. history; hence the economic adjustment period must be longer and more volatile.

If the U.S. economy continues to fall, and if the U.S. government continues to issue large amounts of dollars to stimulate economy, the U.S. dollar might depreciate significantly.

Judging from the performance of global economies, the countries whose currencies are pegged to the U.S. dollar and whose currency system is controlled by the government might face unprecedented pressure.

In retrospect, this round of financial turmoil is just like the collapse of Bretton Woods system in the 1970s, which was caused by fiscal and trade deficits, economic recession and financial crisis in the United States. If the global currency system is to be changed dramatically, the U.S. dollar, theoretically, should not be blamed as the culprit of the financial turmoil, because the U.S. Federal Reserve is a regional central bank and should not be held responsible for globalization's defects even if the U.S. dollar is a global currency. This means that the global financial markets might confront bigger challenges in the future.

In response, the renminbi exchange system should be made more flexible and becomes less connected to the U.S. dollar. Furthermore, China should closely watch the U.S. dollar's depreciation versus the Hong Kong dollar.

Domestic demand

Though some major mainland commercial banks invested in bonds related to Lehman Brothers Holdings Inc. and the two U.S. mortgage lenders, Fannie Mae and Freddie Mac, they did not hold many of the bonds, so that the mainland financial institutions have suffered less of a direct impact from the U.S. credit crisis in the short term.

But we must be careful as the Chinese economy continues to be deeply integrated into the world economy. The U.S. financial chaos might deepen before its property and financial markets are stabilized. Therefore, China should actively pursue new growth momentum as the global economy slows down.

The United States and the EU are China's two most important trade partners. In particular, China's eastern coastal provinces, whose economies rely largely on exports, might suffer the most as shrinking foreign demands take a toll on production and marketing.

Citigroup Inc. predicted that if the U.S. economy slowed down by 1 percent, the Chinese economy would decrease by 1.3 percent. If the U.S. economy underwent a recession, the Chinese economy would be forced to readjust.

Domestically, China's economy is affected by the pressures of economic restructuring and transformation caused by rising energy and labor costs, and increasing consumer and producer prices. Therefore, forced by the global financial crisis and domestic setbacks, the expansion of domestic demand becomes the key issue in determining stable and successful structural changes in China's economy.

 



 
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