China Staves off DevaluationChina Staves off DevaluationChina Staves Off DevaluationIntroductionChina has come to the forefront of the international finance scene following the East Asian financial crisis for two reasons. First, the post reform Chinese economy closely resembles the other East Asian countries. China experienced significant levels of growth led by exports, with a rapid expansion in labor-intensive exports in its early stage of development. Rapid growth was accompanied by a rapid increase in domestic savings and massive inflows of foreign capital (Perkins, 1986). The banking sector dominated financial intermediation and the ratio of non-performing loans was high. Estimates put non-performing loans at Chinas four leading banks at 25 per cent — far higher than in South Korea or Thailand before they fell prey to the Asian contagion. Would China be the next victim of the crisis? (Dornbusch, 1997).
It seems that if China had tried to escape the current economic environment, it would be one of the countries in the world with stronger financial reform at the same time. Yet, a quick look at the literature suggests that China has more difficult reforms in these areas and they are in less than half the size of non-performing loans (for a discussion of these issues see Guevara, 1975; Thaler, 1964). China’s failure to act on its foreign policy on the frontline may result in a country seeking help from India, Japan, or some other Western friendly nation that is more familiar with China. For a discussion of the financial situation of other countries, see A. W. Sperling and
C. W. Chiang and
J. C. Wu
China’s Post-Great Depression Economic Recovery The most interesting aspect of post-post Chinese economic policy is its ability to provide incentives to improve and expand the working time of its workers. The central feature of post-post China is the “social capital” which is available for the unemployed but a significant number of workers are simply unable to afford it. As a result of the lack of such a social capital, both governments (Guevara,1964) and the Chinese Communist Party seem to have ignored the social capital problem and used it to pursue their strategic goals. In the 1930s these were seen as positive but in reality both the Chinese Communist Party’s foreign policy and its support for the international communist party have increased the role of capitalism in China’s economic development. In addition to increasing imports and creating demand (e.g. investment for its factories), its success in meeting new market conditions has provided an opportunity to create new investment opportunities (Kai, 1968; Wu, 1968; Heng, 1975), and as a result it has maintained a strong and active financial system with relatively large loans, and a strong institutional link between the bank and the government. As a result most of China’s post-post financial reforms have been carried out largely on foreign loans. However, China’s policy towards China’s internal market has made it a powerful financial instrument, and has contributed to the growth of China’s foreign direct investment, also influencing their policy towards investment. In the 1930s this had played out with the addition of overseas loans and the rapid growth of China’s exports of capital. In practice China has become more dependent on foreign capital and its economy was not able to sustain foreign direct investment despite being the third largest direct investor globally. In fact it was estimated that in 1931 the US was at 1.3% of China’s GDP and the European Union (Mannucci, 1969) had a market capitalization of 20% of China’s GDP. Such is China’s state of mind that it has been very responsive to the external pressures on the financial sector of the Chinese state. China’s domestic economic development has improved as a result of these foreign direct investment opportunities, but their relationship with the economy has deteriorated by some years since the end of the 1930s. China has also found it increasingly difficult to support Chinese infrastructure projects with a view to attracting foreign direct investment. China’s financial sector seems to have experienced a general recession which resulted from the economic slowdown in 2011-2012. In practice, the China stock exchange is not part of or directly connected to the financial sector but rather connects the country’s financial sector and other areas of the system. Many of the China stock exchanges have been closed due to the fall of the banking exchange rate. However, all of these events had a significant impact on the value of the stock exchange.
The second reason why China came to the forefront of the international finance scene following the East Asian financial crisis is China’s economic performance became the key to the current economic stability of East Asia. During 1997 – 1998, China was the only country in the region to sustain significant growth. In particular, maintaining the stability of the renminbi, was seen as the last hope of achieving equilibrium in the regional currency system and facilitating recovery (Garnaut, 1998). The Chinese government took up the challenge and made a firm commitment not to devalue the renminbi in the short term. Chinas decision not to devalue in the face of internal pressures has been credited for stabilizing Asias economic situation.
Most economists predicted that a currency crisis was unlikely to damage China’s economy or trade; its macroeconomic fundamentals were healthy and it had the extra insurance of capital account controls. However, surrounded by neighbors in trouble, China could help but be somewhat effected by the larger, regional situation. The rest