Impact On China Economic Performance Economics Essay
Financial crisis is a phenomena which a significant decline in activity across the economy. There is a sudden loss in financial assets which caused the decreased in the nominal value. The sudden change of government, import revenues will be decreased, stock market reduces and the outcome of the financial crisis.
There are several types of financial crisis. The first type of financial crisis is called banking crisis. The banks will have a panic run in which the investors are expecting that the value of the assets will decrease if the financial crisis continues to happen. Therefore, they sell their assets in a short time rapidly withdrawing their money from their banking accounts. It will be a triggering in further withdrawals when there is more investors withdraw their money at that particular risky period. As a result, the banks will face a sudden bankruptcy. Long economic decline as people are looking for capital and the domestic banking system will shut down when there is a chain of bankruptcies. As an example of banking crisis, in year 2008, it is a failure of the investment bank of Bear Sterns.
The second type of financial crisis is speculative bubbles and crashes. Bubble occurs in a financial asset when present value of the future income is less than the price. Financial assets can be defined as the stock while future income is the dividends or income which will be receive by having it to maturity. The occurrence of bubble happen, when most customers planning to buy the assets and want to sell it when the assets are at a higher price. There is also a risk of crashing down in asset prices when there is large number of customers have same expectation who are only buying the assets and want to sell it when the price drop. A bubble reliably is hard to detect because it is difficult to evaluate whether an asset's price actually same as the fundamental. Dutch tulip mania, the Japanese property bubble of 1980s, and the crash of the dot-com bubble in 2000-2001 are the example of speculative bubbles and crashes.
The third type of financial crisis is wider economic crises. Recession is defined as the negative GDP growth lasting several quarters. While depression is an especially prolonged recession and economic stagnation is a long period of slow but not necessarily negative growth. Sometimes, they are not considered financial crises because this situation may influence much more then the financial system. Many recessions have been resulted in large part by financial crises is some arguments between economists. Great Depression is one of the examples in this crisis which was preceded in many countries by stock market crashes and bank runs. In late 2008 and 2009, the bursting of other real estate bubbles around the world and the subprime mortgage crisis has brings recession in U.S.
The forth type of financial crisis is international financial crisis. A balance of payments crisis or a currency crisis is the situation which a country sustain a fixed exchange rate and it is suddenly forced to devalue its currency. Sovereign default is happens when a country unsuccessfully to pay back its sovereign debt. Sudden rise in capital flight and stop in capital inflows are caused by changing in investor sentiment. This can seen when both devaluation and default are be the voluntary decisions of the government. In 1992 and 1993, part of the European Exchange Rate Mechanism was involved in this crisis. While, in year 1997 and 1998, Asian Crisis was happened. A devaluation of the ruble and default on Russian government bonds occurred at Russian financial crisis in year 1998.
2.0 Theoretical background or Issues
Financial crisis is a situation in which the value of financial institutions or assets drops quickly. A financial crisis is often related with a panic or a run on the banks, in which investors sell off assets or withdraw money from savings account with the expectation the value of those assets will drop if they remain at a financial institution. The financial crisis will happen in few ways such as bank run, stock market crash and currency crisis.
Bank run is a situation when a large number of bank or other financial institution's customer withdraws their deposits all together because of concerns about the bank's solvency. As more people withdraw their money, the probability of the deposits will increase, that will prompting more people to withdraw their deposits in the bank. In cases, the bank run is usually the effect of panic, rather than true insolvency on the part of the bank. ("Bank Run,"2013) For example Lehman Brothers, had to file for the bankruptcy after begin turned down for support from the Federal Reserve and the customer around the world go to their bank withdraw money, this happen will cause of bank run. ("Financial Crisis,"2013)
Another cause of the financial crisis happen is stock market crash. A stock market crash occur cause of catastrophic events, economic crisis or the collapse of a long-term speculative bubble. In addition, stock market crashed wipe out equity- investment values and are most harmful to the person who rely on investment returns for retirement. Although the collapse of equity prices can be happen in anytime, crash are often follow by a recession or depression.("Stock Market Crash,"2013)
Beside that, currency crisis is a situation in the value of a currency become unstable and making it difficult for the currency to be used as a reliable medium exchange. The currency crisis effect can be mitigated by sufficient foreign reserves. ("Currency Crisis,"2013) For example In Asian have happen the currency crisis was a precipitous drop in the value of the Asian country money and the government have to selling foreign exchange reserves and raising interest rate, which, in turn, have slowed economic growth .In addition the currency crises also has reveled severe problem in the banking and financial sector of the troubled Asian economies. ("Dick K. Nanto,"1998)
The effect of financial crisis in China is unemployment rate increase this is because when the financial crisis happen thousand of companies in China will bankrupt and 10 thousand of workers have been lay off or early retirement. ("Dirk Schmidts,"2009) In addition, the employment rate high also caused the investment in China are decreased because household income are affected by the increasing inflation and decrease the purchasing power of the China Yuan. Besides that, it also will affect the currency trading in China, a high unemployment rate means that the economy in China is highly unstable, and the currency become volatile. Import will become more expensive and the export will become cheap. Therefore, tax revenue in China will shrink as growth slows and corporate profits will fall down. China may also face higher debt service form currency depreciation and rising interest rate. The impact forecast on overall fiscal balances could be very large.
Besides that, stock market crash has wiped out more than two-thirds market value although the stock has dramatic collapse of China stock market. On the other hand, the China banks have profitability witnessed the suddenly pull out of many of their Western partner had sell all their stock in order to retrieval capital. This trend will bring the negative consequence for China banks remind to be seen. ("Dirk Schmidts,"2009)
3.0 Discussion and Argument
Background of Crisis
Based on journal article we found, financial crisis is the issue that happened and existed for many years, and we believe that it can never be wiped or solved at least for next few decade, it is the issue that created by several main financial problem including oil bubble, global housing price bubble, low interest rate policies, low saving rate in some parts of the global economy and high saving rates elsewhere and trade surpluses and deficits.
The financial dimensions of the financial crisis at first was became evident in the problem with sub-prime mortgages in the US when in mid of 2007. Sub-prime mortgage is the term that use to explain that those mortgages are advanced given out to those low income households at the initial interest rates at below the prime interest rates. Because of the abuse of sub-prime mortgages some of the US house prices that been build after 2001-2002 was rapid increase by as much as 30 percent per year. The issuance of this sub-prime mortgage was in a part of response by US financial institutions.
The reason why so much low-income households taken those sub-prime mortgages is because they expect of ever-rising of house prices can let them stand a chance to grab a sudden huge profits but in face those mortgages could only be continue to serviced on the basis of further capital gain means the house price are keep on raising or the further growth in the mortgages. But eventually the financial crisis snowball was begun to roll when the US house prices began to plateau and fall.
This problems happened occurred in similar forms at many other country and its mostly occur in western country, in fact those mortgages that had been issued in the US is already been repackaged and resold through many complex financial instruments, it had became something that not similar with the original form of mortgages and one of the mortgage was the one so called asset backed commercial paper, even worst most of this mortgages paper had often been graded as AAA by rating agencies which mislead the public believed that this mortgages was safe and the one can be invest their money in and so does many of the investors had been purchased huge quantities of these mortgages.
When the true value of this paper become questionable and public had been asking how much of this paper really worth the stability of the entire banking system was threatened and the elements of financial excess in other area of the global economy are no more invincible but became apparent and similarly unwind. First, it causes a huge impact in commodity prices especially oil, and in exchange rates. This country who having smaller economic such as Iceland, Hungary, Argentina and others who had large amounts of US dollar-denominated debt had experienced enormous difficulties that, as for the declared bankrupt case by Icelandic were compounded by those deregulated banks that made aggressive loans and most of the investment of they put was those high interest rate of deposits in Europe.
All these developments reached a climactic proportions in September and October 2008 as a sharp and sudden falls in US stock prices and major liquidity problems, when US stock market shaking it implicated the others countries stock market and cause it all fall at the same time. Many country banking systems start to posed major problems of solvency for companies worldwide and these threatened to plunge the world into recession and two of the US multinational corporation automakers, General Motors and Chrysler filed for bankruptcy.
The global recession had caused a one-third of reduction in house prices worldwide in a relatively short time and so do a similar fall in stock market prices, in effect the world financial system becomes insolvent. The major factor of precipitating the large declines in stock prices that occurred worldwide in 2008 was the fear of global financial insolvency. At the weekend G7 meeting, there was an agreed statement of an underwriting of all deposits to the sum of 1.7 trillion. This was subsequent to as US bailout passed by the US Congress. After the G7 meeting the issue of the credibility of banks had largely removed due to the commitments by national governments and the banks being able to meet their deposit liabilities.
All the government actions and commitment seem to have temporary calmed the financial markets, the LIBOR rates have fallen to around half of their peak levels and the liquidity had begun to move within the world banking system. But the situation of worldwide remains fragile due to the huge amount of worldwide dollar liabilities, government debt, trillion of commercial paper, large amount of default swap arrangements and so on. All of these liabilities cannot be honored on the basis of current income accruing to US governments and US corporations.
Many of the US corporations still have the significant pension liabilities, which will cause the difficult to honor due to the reduced of asset values. There still seems substantial disarray on the real side of the economy as consumers defer or reject the purchases of durable goods including cars, house and other goods which required huge amount of money. The precautionary savings sharply increase, unemployment rate rises, GDP growth goes negative and world trade falls. The plunge in the stock market which struck in September 2008 ultimately saw a fall in stock prices by as much as 80 percent. World trade also plummeted by 80 percent in just two years time, many banks failures on handle the issue and lack of fund to weather the storm cause a large number of bank closures.
The degree and form of the disturbance and turmoil that created by the series of events of September and October 2008 render highly uncertain the period of recovery for the global economy. Some of the large firms in the OECD economies had no choice but substantial layoffs and large manufacturing entities in Europe have suspended production for varying periods. However since March 2009 there has been strong recovery in the global stock markets and the current market situation of year 2013 remain stable.
Impact on China Economic Performance
The impacts of the financial crisis thus on China's economic performance are reflect in many other indicator.
The GDP growth rate in China has fall down of the financial crisis, thought not to the extent in other large economies. On 2009 year the first quarterly growth rates have fall down 4.5 percent compare to the first quarter of 2008 year.
Industrial output had increased 5.1 percent in the first quarter of 2009 and it had increased 8.3 percent in March, this reflection the bottoming out that is characterizing the more recent stages of the financial crisis.
The Consumer Price Index (CPI), the main measure of inflation, it fell 1.2 percent compare to a 1.6 percent decline in February. On the other hand, China Producer Price Index (PPI) had fell 6 percent in the first quarter, year on year, while retail sales grew 15 percent as China started to implement the stimulus package announce in November to counter the impacts of the global slowdown.
On the trade front, China exports have been badly caused of global financial crisis has been intensified. China export has fallen in January 2009 and continues February 2009 and compared to the corresponding months in an early year. In the March and April, exports have recovery and it was down back in May. The similar falls have occurred in import. In addition, the balance of the initial months of 2009 has remained in substantial surplus despite falls in export, as imports also fell sharply.
The last is house market, the property have decline in March and April compared to the previous year but showed a rising trend on a monthly basis and the China government priority throughout has been to support the economy reduce the unemployment rate and injected a large fiscal stimulus and implemented a relaxed credit policy help to risk total bank lending.
Implications for China
China has a higher ranking relative to OECD economy. The foreign exchange reserves of China are bigger by improving its performance. The financial institutions of China are easy to perceive by using the complex financial instruments which are more volatile in US and Europe. Rural areas in China are difficult to receive the China's financial institution. Therefore, it has proposed that China is more indistinct than US and Europe. US and Europe wish China to maintain and reinforce a declining global economy. However, there may have problems that make China unable to function well.
The first problem is the growth of China is depends on exports. While China is integrates into the global economy by conducting developmental strategy. China is the second largest exporter. This can be evidence that in the last three pre-crisis, China's exports are increased 30 percent per year. Due to global declination, the China is given the power in integration and the economy is needs a big adjustment. The drop in China's exports are become small because there may be a replacement in OCED countries from high-priced and high quality consumption of branded products to lower-priced consumption of China's products.
Coactal zones which associated with China's export activity were bankrupt and closures. China was concentrated in sub-segments of export markets such as toy markets and changed the labor laws in 2008. Financial crisis make the continually growth of China's GDP and facing problems in export. Input sides will be helped when the commodity prices decrease. However, by relative to other costs for Chinese exports, the wage costs are increased. The size of overall export drop is the most concern thing and follows by the increased in protection. This can be proved when China has been growing in antidumping action against its export and also the buy and hire American in the US congressional debates.
There is a set of priorities for China and the share of China in global markets is large. House prices are another element in China. Few years before the crisis, the house price in large cities such as Shanghai and Beijing had expanded. Moreover, there is disarray and distress in China's financial institutions when there is drop in house prices. Some reconsideration happen when there is a significant further slowing clearly and slow growth. This may gain the problems if the broad developmental approach is depend on the domestic market rather than associated foreign direct investments and domestic market.
Policy responses in China
With the large reserves of China, China enforces their currency exchange rate policy. China should be able to maintain exchange rate at stability level if China remains an objective of policy. One rule will never change in this crisis, if the country currencies rate remain stability or appreciation of the currencies of that particular country will attract more foreign investment on that particular country. If China can able maintain and appreciate on their currencies renminbi will helping a greater shift towards reliance on the domestic market. This move will also can help to reduce the further accumulation of foreign reserves, representing accumulation of paper by China in return for goods exports. But there was also disadvantage by implement this policy, which is cause the substantial distress for the exporting firms from China, where many of the exporting already declared bankruptcy and unemployment rate has risen in export enterprises.
China had try to help those critical real estate and construction sectors which is the sectors that affected the most in this financial crisis, however there are also issues too focus on the policy on helping this sectors, review the previous year the GDP on construction sector had accounted for over 10 percent in 2007, as expectations of higher growth fuelled a building boom. Now further expansion or development on construction sector seems likely to be put on hold perhaps for next several years. Besides that, there are also some issues on policy towards the housing market area. China had higher down payments charges on mortgages than in the OECD (organization for economic cooperation and development), in response China government had reduced the stamp duty from 1.5 percent to 1 percent, but it might insufficient. For other measurement such as including interest rate subsidies to apartment buyers and some degree of co-financing of purchases by government agencies. All this measurement may be needed and could prove costly in budget terms and in the long run mainly serve to draw the China government targeted as a largely private sector activity.
Management of China reserves also a key part of the policy mix, the reserve in a country can use to stabilize the countries' currencies exchange rate and same goes to China renminbi. By managing the China reserves can help to stabilize the reminbi exchange rate, when the period of financial crisis there are many sectors and foreign financial institutions desperately need fund to turnover, by loans to those companies and sector that can provide some degree of stability to the global economy. But there are also one issue in this, if China disposes its reserves too quickly, there could cause a fall in US dollar and new global instability since on that current situation US dollar still is the main currencies that use to trading in global market. But if China does not dispose the reserves the face value of US dollar will continue to fall and China would suffer from high capital losses.
4.0 Recommendation and Conclusion
Firstly, financial rescue plan is on purpose to save those insurance company and investment bank have the highest value from bankruptcies. This move is to avoid further financial corrosion in China. China central bank play an important role to support this plan because they are the one has this ability and also responsibility.
Secondly is China central bank need all monetary policies to control the financial crisis. For example, central bank must decrease the interest rate radically. This can help to minimizing the cost to borrow the money for consumer and private company which can stimulate the commercial activities.
Thirdly, China government can launch public stimulus packages to help in financial crisis. In financial crisis, consumer spending decreased sharply because of fear and lack of security. Thus, the total industrial output will decrease and unemployment will increase sharply. Stimulus packages help to enhance the public spending of infrastructure projects. Public spending can produce extra jobs and stabilize spending pattern of consumers.
Fourthly, China government fiscal policies are important. Although government fiscal spend is important but the public spending should focus on activities like construction and infrastructure actions that can eventually lead to economic growth of China. For example, if China focuses on the spending on subsidy plan and unemployment benefits, it will not have a long term effect. These kinds of short term activities will only worsen the future economic growth of China.
Lastly, China Government and central banks must have financial market supervision and regulation. Government and central banks must take seriously method on supervising the monitoring the activities of financial firm and banks locally. In short run, balance sheet of bank and financial firms must be clean from the useless assets. For example, only company with good practices would be offered with the credit lines. Government should also monitor the tax reports of financial company using both internal and external audit firm.
In conclusion, we found that financial crisis is unenviable phenomena in the world and there is no real solution for financial crisis. In China, there are several causes like global housing price bubble, low interest rate policies, low saving rate in economy and high saving rates elsewhere and trade surpluses and deficits.
Financial crisis is bad to the health of country because it will increase the unemployment rate and dramatically decrease the value of stock market. Besides that, tax revenues will decline and demand for exports will also lower. We can know that how big impact it brings to a country during financial crisis.
From the journal article titled "China and financial crisis", we have read through it and we found that it also brings a negative impact to China especially in economic performance. China government has enforced currency exchange rate policy, assist important real estate and construction sectors and management of China reserves. It is relatively a good move by China.
Last but not least, we have recommended some solution based on mixture of journal article and our opinion. China should adopt financial rescue plan, provide a strict financial market supervision and regulation and launch the public stimulus packages. Besides that, China government fiscal policy and monetary policy also play important role during the financial crisis. We strongly believe that our recommendation can help to help China during financial crisis.
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