Thursday, October 9, 2008

Will China's financial markets follow the U.S.?

With the financial sector shaken to its core and the housing market still reeling from the subprime mortgage crisis, the U.S. Government has been forced to launch its largest-ever rescue campaign. But it seems that the current challenges plaguing the United States defy quick or easy fixes. Worse still, the crippling financial situation has sparked gnawing worries among investors about a slowdown in the overall economy. Will the financial chaos leak into America's broader economy? Will China's financial markets succumb to the Wall Street-generated gloom? How should China prevent itself from becoming the latest casualty of the crisis? The 21st Century Business Herald, a domestic economic newspaper, interviewed Wang Zili, President of the Training Institute under the People's Bank of China, for some answers.

Beijing Review
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October-7-2008 NO.41 OCT.9, 2008

The 21st Century Business Herald: The shockwaves that engulfed Wall Street have reached an intensity never seen before. Is the U.S. financial crash bottoming out, or is there an even more overwhelming storm yet to come? How heavy a blow will the financial turmoil deal to the real economy?

Wang: Recently, the United States has come under the global spotlight for a rash of upheavals in its financial institutions. The Federal Reserve (Fed) has taken control of Fannie Mae and Freddie Mac to bail out the two beleaguered mortgage financiers. The fourth largest U.S. investment bank, Lehman Brothers Inc. (Lehman), has filed for bankruptcy. Mixed developments in the financial sector have kept concerns about embattled American International Group (AIG), the country's largest insurer, simmering despite a $20-billion lifeline thrown by the Fed. The market jitters nowadays are growing about who is next in line.

It's widely believed that the U.S. financial crisis has reached a peak. I personally estimate that another one or two financial giants will fall victim to the debacle, accompanied by the collapse of an array of medium-sized investment banks. With gloomy sentiment taking hold over the markets, there is no end to the crisis yet in sight. Since signs of credit stress are proliferating in the markets, the engines of the U.S. economy, which relies on credit to fuel growth, have essentially been stuck.

But what's worse is that U.S. financial credit may even dry up if massive global capital flees the U.S. capital markets to stave off further losses. If that occurs, the hopes of containing the damage to the financial system will evaporate. In other words, the real economy will also be woefully pinched. That would be the greatest depression in the country since its founding, substantially denting its overall strength.

The U.S. Government took pains to bail out Bear Stearns, Fannie Mae, Freddie Mac and AIG, but turned a blind eye to the demise of Lehman. Why has it selectively played tougher with Lehman Brothers?

The U.S. Government has a reason to let Lehman go. The seizures of Fannie Mae, Freddie Mac and AIG were meant to shove the losses of the financial giants that have made bets on mortgages into the hands of taxpayers. As a result, the bailout has come under heavy fire by the U.S. Congress. Moreover, Lehman is not the last or the most worthwhile of U.S. financial institutions in need of a rescue. Meanwhile, orderly windups in the markets must be allowed, where needed.

Globalization has intertwined the fates of the world's economies. So what should emerging markets, including China, do to shrug off the ripple effects of the current U.S. contagion?

As the global economy now appears to be on uncertain footing, emerging markets are in fact more prone to financial instability due to the patchy regulations of their financial sectors. The current U.S. washout brings to mind the financial crisis that convulsed Asian countries 10 years ago, as both are reminders that supervision outweighs innovation in the financial sector. As a result, the emerging economies are supposed to plug their loopholes in financial oversight and supervision so as to ensure a healthy and stable financial system.

It is estimated that the stabilization of the U.S. financial system is still some way off. Since the big-picture trends of the American markets are yet to be on full display, China should keep a vigilant eye on the movements of the international markets and also on the price swings in its domestic housing and securities markets. At the same time, we should maintain a close watch over the massive inflows of speculative hot money, which may stir up turbulence in the country's financial sector. In the years to come, China will remain most attractive to hot money among emerging markets.

Is China's financial regulatory system firm enough to weather what former U.S. Fed chairman Alan Greenspan described as a once-in-a-century storm? Can the country counteract such a crisis swiftly?

China's financial regulators have so far put in place a series of financial risk-control and emergency programs and also made efforts to strengthen their financial risk valuation and pre-warning system. That would add to China's resilience to the U.S. stampede.

Besides this, the coordinating efforts of China's several financial regulators may also help with its immunity to financial risks. The State Administration of Foreign Exchange could track hot money inflows and collaborate with foreign trade regulators to crack down on fake trades that illegally allow in hot money. Also, China could join hands with other countries to oversee international short-term capital.

China's central bank has recently cut its loan interest rate for the first time in the past six years and has allowed small and medium-sized financial institutions to set aside less money in reserves. What is the purpose of this, and how will it affect the Chinese economy?

The looser monetary policy reflects the country's priority switch from fighting inflation to shoring up economic growth. With a solid foundation and monetary stimulus, the broader economy will continue to hold steady.

The Chinese economy has maintained rapid growth for 30 years, registering an average 9.67-percent annual rise in the GDP. But such breakneck growth was only contingent on high input, heavy pollution and resource depletion, which are unsustainable. With resource and pollution treatment costs surging and the global economy cooling down, the Chinese economy is destined for a restructuring of its growth model.