The Impact of Financial Crisis on China Foreign Trade
Name: Bai Ya-nan Student ID: S08093
Research paper supervisor:Dr.Sekou Conde
Minzu University of China
2008-2009 Academic Year
Abstract: Begun in the second half of 2006, the subordinated debt crisis in the United States turns the financial market into a complete turmoil. After setting off huge waves in the financial markets of the United States, the thunderbolt is rapidly expanding to Europe, Japan and other major financial markets all over the world. In response, the governments scrambled to prop up banks, reduce interest rates, inject investment on public projects and take protectionist policies, which has a negative impact on the foreign trade dependent countries. The current financial crisis has many unique features different from the previous ones. This essay is mainly dealt with the causes and effects of the crisis. Thus grasp the essence of the financial crisis and come up with response measures toward the influence on Chinese economy, especially on foreign trade.
Key Words
Financial Crisis, Foreign Trade, Cause and Effect, Response Measure
Introduction
In the fall of 2008, the credit crunch, which had emerged a little more than a year before, ballooned into Wall Street’s biggest crisis since the Great Depression. As hundreds of billions in mortgage-related investments went bad, mighty investment banks that once ruled high finance have crumbled or reinvented themselves as humdrum commercial banks. The nation’s largest insurance company and largest savings and loan both were seized by the government. The channels of credit, the arteries of the global financial system, have been constricted, cutting off crucial funds to consumers and businesses. The governments around the world are taking immediate reactions to counter the severe impacts. After analysing the features and causes of the current financial crisis, this essay will mainly dissect the impact on Chinese foreign trade and give some response measures.
A)Characteristics of financial crisis
The financial crisis exploded in 2007, has some unique features. It first erupted in the developed countries, then spread all over the world. The severe impact hit the historical record. It erupted in the sphere of financial sector, rather than the real economy. Take the depression in 1929-1933 as an example, it broke out because of overproduction. While the current crisis exploded not only at the center of the world economy, but also at the heart of American economy. It began at the sphere of financial sector. The root to bring about this crisis is over-consumption rather than over-production.
1. Severe Impact
This financial crisis is noted for its broad influencing scope. It swept the entire capitalist world and the developing countries.In 2008, a series of bank and insurance company failures triggered a financial crisis that effectively halted global credit markets and required unprecedented government intervention. Fannie Mae (FNM) and Freddie Mac (FRE) were both taken over by the government. Lehman Brothers declared bankruptcy on September 14th after failing to find a buyer. Bank of America agreed to purchase Merrill Lynch (MER), and American International Group (AIG) was saved by an $85 billion capital injection by the federal government.[1] Shortly after, on September 25th, J P Morgan Chase (JPM) agreed to purchase the assets of Washington Mutual (WM) in what was the biggest bank failure in history. In fact, by September 17, 2008, more public corporations had filed for bankruptcy in the U.S. than in all of 2007.[2] These failures caused a crisis of confidence that made banks reluctant to lend money amongst themselves, or for that matter, to anyone.
As more and more evidence is gathered and as the lag effects are showing up, in Iceland where the economy was very dependent on the finance sector, economic problems have hit them hard. The banking system virtually collapsed and the government had to borrow from the IMF and other neighbors to try and rescue the economy. The government of Ireland announced that it would guarantee payments on as much as $563 billion in bank debt (including securities, short-term borrowings, and individual deposits).[3] The economic problems have also led to political challenges including protests and clashes in Iceland.
2. Financial Area
The current crisis is exploded in the financial sector rather than the industrial one. It is not caused by over-production but the excessive consumption. Some financial products and instruments have become so complex and twisted, that as things start to unravel, trust in the whole system started to fail. The financial instruments such as securitization where banks would pool their various loans into sellable assets, thus off-loading risky loans onto others.[4] Rising house prices led lenders to think it wasn’t too risky; bad loans meant repossessing high-valued property. Subprime and “self-certified” loans, sometimes dubbed “liar’s loans”, became popular, especially in the US.
Each subprime mortgage alone would deserve a "junk" rating. Structured finance piles such risky assets into bundles and slices the bundles into tranches. The securitization process had become so complicated and opaque that the ratings agency had to rely on the issuer’s data. This system worked as long as housing prices increased. Systemic risk was ignored as more and more sub-prime loans were securitized. As long as the security’s mortgage interest cash flow was maintained this was a successful strategy but as more and more mortgages went into foreclosure, the value of the securities dropped requiring assets to be sold to maintain capital ratios while at the same time cash flows that paid the debt dropped, placing the owners of the securities close to or in default.
When people did eventually start to see problems, confidence fell quickly. Lending slowed, in some cases ceased for a while and even now, there is a crisis of confidence.[5] Some investment banks were sitting on the riskiest loans that other investors did not want. Assets were plummeting in value so lenders wanted to take their money back. But some investment banks had little in deposits; no secure retail funding, so some collapsed quickly and dramatically.
B)Causes of financial crisis
The 2007-2008 financial crisis first exploded in the United States and then spread all over the world, do have some similarities with the previous financial crises. The deregulation of financial market encourage the excessive creation of financial instruments, as a result of implement of neo-liberalism. While it also has some unique features. The excessive currency all over the world flowed to American to earn profit. The subprime mortgage loan provided a market for them to increase value.
1.Neo-liberalism
The occurrence of financial crisis is the implementation of neo-liberal economic and financial theory and policy in the United States for nearly 30 years.[6] Financial markets did well through capital market liberalization. Enabling America to sell its risky financial products and engage in speculation all over the world may have served its firms well, even if they imposed large costs on others. Furthermore neo-liberalism widen the gap between rich and poor dramatically. The wealth owned by the richest 1% and 1 ‰ of the United States population in 2005 reached the summit since 1928. The revenue of richest 1 ‰ population (300,000) is equal to the total income of poorest 50% population(150 milliom).[7] Under the condition of neo-liberal policies, workers stay at the weak position compared with capital. The society failed to provide sufficient assistance for workers, leading to a dilemma of rising profit with decreasing wages.
Differentiation between the rich and poor triggered the problem that the relatively low purchasing power can not afford the ever-increasing products. As a result, at the beginning of the 21st century, the income level of working families is stagnated or diminishing. They had to carry out housing as collateral in order to maintain the previous living standard. By 2006, the debt has been become too high to endure. Working families found that they could not get any lending by their income and pay back those debts. Then there comes the crisis.
2.The excess liquidity
In recent years, the structure of world economic growth is going through a significant change. The developing speed of the industrialized countries show a tendency of slowdown, while the emerging markets accelerate its growth pace. Along with the abating innovative ability in the high-tech industries, the world economy is now heading toward the technological competitive development rather than cost competitiveness. Intensifying of the global cost competition brought about the deflation effect, resulting in reducing money demand. Given the certain currency supply, the problem of excessive liquidity is inevitable to emerge.[8] For instance the world's major economies promote the emergence of excess liquidity in general. Several years of expansionary fiscal policy and the huge trade [...]
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