Chinese economy in the aftermath of the global financial crisis : challenges to macroeconomic rebalancing

AbstractWhen the global financial crisis erupted in the United States in the fall of 2008, the Chinese economy was seen to be relatively immune. However, this optimism proved misplaced. The contagion quickly spread to China, albeit, the overall impact was moderate - at least when compared to many other advanced and emerging market economies. How and why was China impacted by the financial crisis? In particular, what were the "transmission channels" via which the contagion spread into the Chinese economy? How has Beijing responded to the economic and sociopolitical challenges unleashed by the crisis, and how effective have been their responses been? Furthermore, what must Beijing do over the long-term to rebalance its economy and make it less vulnerable to domestic and external shocks? This paper addresses these interrelated issues.Keywords: global financial crisis, Chinese economy, economic rebalancing, stimulusJEL classification: E32, E44, E52, F02(ProQuest: ... denotes non-US-ASCII text omitted.)1. Introduction1Even as the global economy was gripped in the throes of a spiraling financial crisis following the collapse of Lehman Brothers in September 2008, China was among a handful of economies that conspicuously remained an outlier. Not only was the Chinese economy booming - notching an impressive 9.3 per cent growth in GDP in 2008, Beijing's top priority was to dampen the inflationary pressures and prevent the economy from overheating. To many analysts, such starkly divergent trajectories reflected by the world's largest and second largest economy could be explained by a single fact: that the Chinese economy had tangibly "decoupled" from the American economy. More specifically, the China-centered trade integration in Asia and the massive ability within China's economy to generate a domestically driven demand meant that the Chinese economy had become decoupled or that its business cycle had become less synchronized with that of the advanced economies, notably the United States and Western Europe.2 Predictably, this led observers to conclude that China was immune from an economic slowdown emanating from the US and Europe.To others, China's immunity was due to the "cushion" Beijing enjoyed because of its substantial foreign exchange reserves. Beijing's holdings of US Treasury debt skyrocketed from about US$46 billion in 1998 to US$587 billion by 2008.3 According to the US Treasury, China's investment in Treasury bonds totaled some US$585 billion in September 2008, compared to Japan, which held US$573.2 billion worth (Table 1). Moreover, in mid-2008, Beijing held the world's largest cash reserve of roughly US$2 trillion.4 This was not counting an additional US$800 billion as Beijing also purchases US debt through third countries which are not recorded by the Treasury as being held by China. This meant that on the eve of the crisis China owned US$1 out of every US$10 in US public debt. This made Beijing the largest foreign holder of US government debt - indeed, the US government's leading foreign creditor - and the world's leading creditor nation, while the United States became the world's largest debtor.Rather ironically, if earlier, vilified for creating the "global savings glut" seen as responsible for the crash of 2008, Beijing's formidable reserves were now seen as a source of much needed global liquidity in an increasingly capital scarce world.5 Not surprisingly, it was suggested that the wellendowed and booming Chinese economy could serve as a potential "shock absorber" and "locomotive" to help drive the global economy out of its deep malaise (Dobson, 2009).Others were upbeat because China (like the other major Asian economies, namely, Japan, India and South Korea) had only modest exposure to the "toxic" subprime loans and structured credit products originating in the United States as the Chinese financial sector does not trade much in derivatives (Lardy, 2010). …