The U.S. is the Cause of the Financial Crisis. China Cannot Be Blamed

Recently, certain scholars and politicians from the West have expressed their opinions in the media, criticizing the high savings rates of China and other countries for encouraging Americans’ excessive spending and asset price bubbles. They also claimed that the root of this financial crisis stems from Asian countries, led by China, which have a high trade surplus. How exactly should we look at the causes of this global financial crisis? How should we look at this “theory of Chinese responsibility”? Why did this theory emerge? On January 16, Xinhua interviewed Zhang Jianhua, research director at the People’s Bank of China, regarding this topic.

The “root” of the financial crisis is in the U.S.

Xinhua reporter: Starting from the bankruptcy of Lehman Brothers, the financial crisis, which has spread globally, has gone on for five months already. What exactly is the reason for this crisis?

Zhang Jianhua: This global financial crisis is not over yet. It may still be too early to sum up the lessons we have learned from this experience, but from several major standpoints, the U.S.’s macroeconomic policies have slipped up, and the major defects in the global financial system and insufficient supervision are undoubtedly the main causes of this crisis.

At the macro level, the U.S.’s economic policies only pay attention to domestic problems and neglect the responsibility that the U.S. dollar should assume as an international currency. In the end, these factors caused the crisis. In the year 2000, the U.S. dot-com bubble burst. To boost the economy, the U.S. Federal Reserve decreased the federal funds rate 13 times, reaching 1% in June 2003 and June 2004, the lowest points in history. The Federal Reserve maintained this low rate for quite a long time. In terms of financial policies, after 2001, the U.S. government instituted large-scale tax cuts in order to boost economic growth, further unbalancing the U.S. economy, which was already overly reliant on consumer spending as the main economic driver. In addition, the wars in Afghanistan and Iraq continually increased the U.S. government’s expenses and overall deficit. The financial deficit policies and large-scale tax cuts implemented by the U.S. promoted economic growth but also hastened the growth of the real estate bubble at the same time. The “wealth effect,” caused by overly high asset prices, further encouraged Americans’ excessive consumer spending until the crisis broke out.

If we look at the world’s current financial and monetary systems, the International Monetary Fund (IMF), whose responsibility is to maintain global financial safety and stability, has recently been putting more effort into dealing with the financial risk of developing countries and emerging markets and has not paid enough attention to the more influential developed countries – especially the economic and financial stability of major countries that issue reserve currency. The IMF has not only failed to give proper advanced warning but has also not dealt promptly enough with the crisis.

At the micro level and from a supervisory perspective, this crisis reveals more prominent problems.

First, U.S. financial institutions, represented by the major investment banks, have serious flaws in business and risk management. These institutions ignored risk control, chased after short-term gain, lacked a checks-and-balances system, and planted many hidden dangers that triggered this crisis. For example, the board of directors of some financial institutions let supervisory-level employees seek maximization of short-term profits and neglect appropriate evaluation and effective risk control. They even encouraged fraudulent property sales and management activities in order to pursue market shares, career advancement, and large bonuses. This “gentlemen’s club” style of business management had no way to prevent high-level management, driven by short-term gains, from overindulging in risky activities.

The second problem is excessive innovation, which led to an increase in financial risk. Normally, financial innovation is beneficial to enhancing the efficient use of capital and diversification of financial risk. However, excessive derivatives and the lack of effective management resulted in a mismatch between the risk and profit of financial institutions. Risk was not diversified but was instead magnified greatly. Regulatory agencies did not truly assume their responsibilities as the “watchdogs” of the market, not only because profits create a certain moral hazard but also because of “market-watch” accounting standards. Altogether, they promoted the upward spiral of asset prices and the build-up of the bubble, accelerating the speed at which the property bubble burst.

The third problem involves the major defects that exist in the financial supervisory system. In recent years, the financial authorities of some developed countries, such as the U.S., put too much trust in the rationality of the market and pursued a long-term laissez-faire management philosophy. Loopholes in the supervisory system gradually increased the risk in the financial system. Insufficient supervisory methods prevented the timely, effective implementation of measures to deal with problems as they arose.

“Theory of Chinese Responsibility” is absolutely ridiculous.

Xinhua reporter: When interviewed by the U.K.’s Financial Times, Treasury Secretary Henry Paulson, who will soon step down, claimed that the source of the financial crisis and global economic instability lies in countries such as China, which have a high savings rate. How should we look at this “theory of Chinese responsibility”?

Zhang Jianhua: This viewpoint is extremely ridiculous and irresponsible and can be classified as “gangster logic.” This financial crisis erupted during a period of global economic instability. On the surface, the financial crisis seems to have something to do with the global trade imbalance on some levels. However, as we just discussed, the multiple mistakes made in U.S. economic policy, financial supervision, and financial markets are actually the fundamental causes of this crisis. If we blame the global economic instability on countries with a trade surplus, then that is obviously shifting responsibility and cannot be justified.

The U.S.’s low savings rate and large trade deficit are a result of the country’s own long-term policy decisions and consumer behavior. China’s high savings rate and large trade surplus are not the cause of the U.S.’s low savings rate and large trade deficit. In terms of time, there is an obvious time difference between the occurrence of China’s high trade surplus and the U.S.’s low savings rate, and there is no cause-and-effect relationship between the two.

Actually, before China had huge foreign exchange reserves, the U.S. had already formed the habit of high consumption. During the Great Depression of the 1930’s, the personal savings rate of the average American fell below zero, and in 1933, it even fell to a historical low of -1.5%. The U.S.’s new pattern of decreasing savings rates started from 1984, continued to decrease to a level of about 2% in 1999, and persisted for another six years, on average falling below 1% between the years 2005 and 2007. The U.S.’s trade deficit began from the beginning of the 1980’s and continued for almost thirty years until now. The U.S.’s financial balance has been at a deficit many times within the same period, except for the time between 1998 and 2000, which was during the last few years of the Clinton administration. So, this pattern is not a recent phenomenon. However, China’s foreign exchange reserves have only started to experience large increases starting from 2003. Obviously, the viewpoint that China’s trade surplus caused the U.S.’s high consumption cannot be substantiated. There are two fundamental reasons for the U.S.’s high consumption and trade deficit: 1) The U.S.’s own expansive domestic policies stimulated increases in personal and public expenditures, causing the savings rate of regular citizens and the government to continually decrease; 2) While satisfying domestic market demands through massive imports of consumer goods, the U.S. imposed various barriers against exports, preventing exports of new high-tech products to developing countries. The integrated effects of both factors caused the continual decrease in the U.S.’s savings rate and the large rise in the trade deficit.

In recent years, Asia’s emerging markets, including China, strengthened foreign reserves and domestic savings. These are the crisis-management measures that these countries learned from the Asian financial crisis 10 years ago. Actually, this is the “prescription” that the IMF gave to Asian countries during the financial crisis. In the process of helping countries weather the Asian financial crisis, the U.S. government directed the IMF in formulating rescue plans and conditions for Asian countries. In the “prescription” that the IMF gave to Asian countries, one important point was that Asian countries should tighten up monetary and fiscal policies, increase interest rates, reduce financial deficits, and increase foreign reserves.

In the past 10 years, Asian countries, especially those that were impacted by the Asian financial crisis, learned a lesson. They increased foreign reserves and domestic savings and strengthened their ability to resist financial crises. However, certain people in Western countries interpret these as the causes of the current financial crisis – a theory that is obviously self-contradictory.

I personally believe that in addition to absolving certain major Western countries from their own mistaken economic policies and weak supervision, this “theory of Chinese responsibility” lets these countries find an excuse to issue protectionist trade policies or put more pressure on China. We should have a clear understanding of this and provide further clarification, or else it will prevent us from strengthening international cooperation, fighting against trade protectionism, and working together to address this crisis.

The global economic imbalance is the result of manufacturing specialization initiated by developed countries

Xinhua reporter: Certain Western countries theorize that the financial crisis boils down to a global economic imbalance and China’s trade surplus. Now, how do we understand the present global economic imbalance? How did it come about?

Zhang Jianhua: On major levels, China’s trade surplus reflects changes in international specialization and trade patterns. From a global perspective, this type of change is the result of developed countries promoting further specialization of manufacturing.

In the past 20 years, the U.S. and other developed countries have completed the transfer of low value-added manufacturing sectors to developing countries, resulting in developed countries relying more and more on imports in order to satisfy demand for manufactured products. The trade surplus of emerging markets is the inevitable result of this new type of job specialization. A huge trade surplus is not the goal that China has been pursuing, and this current pattern of job specialization is not something that China itself has the power to choose. China’s increase in exports is the inevitable result of shifts in global industries, specifically resulting in the following three occurrences: 1) Staring from 1999, the trade surplus in processed goods was higher than the total trade surplus that year. In the first three quarters of 2008, China’s trade surplus was 180 billion USD, and the trade surplus in process manufacturing reached 210 billion USD. 2) Between 2002 and 2007, the trade surplus of foreign enterprises in China rose from 31% of the total trade surplus up to 51%. In the first three quarters of 2008, the trade surplus of foreign enterprises increased to 61% of the total trade surplus. 3) The change in exports is obvious. Developed countries are not only moving their manufacturing industries to China; some emerging market economies are also moving manufacturing to China. In the past few years, China has had a greater trade surplus in relation to the U.S. and Europe, but China’s trade deficit with some Southeast Asian countries and petroleum-exporting countries has continually increased. A sizable portion of China’s trade surplus is due to enterprises in other countries coming over to China.

In terms of imports, China’s low level of imports is not something that China wished upon itself. This is actually related to some developed countries putting up high-tech trade barriers with China. China’s fast economic growth has greatly increased demand for high-tech products. From a more advantageous standpoint, China should import a large amount of high-end products, but developed countries have put up multiple trade barriers, both restricting and prohibiting the export of high-tech equipment to China. This has caused China’s growth in imports to continually lag behind growth in exports, increasing the trade surplus.

We also believe that correcting the global economic imbalance cannot be achieved in one day but requires the joint efforts of major trading countries over a considerably long period of time. In today’s world, the actions of large countries have a very important influence on the resolution of global imbalances. First, the U.S. must quickly carry out adjustments in its policies, decrease the financial deficit, increase the domestic savings rate, strengthen financial supervision, and decrease limitations on exports of high-tech products. Since the U.S. dollar is the reserve currency, the U.S. government’s policies regarding the dollar cannot just blindly pursue its own economic goals but must take on responsibility as a major country in the world and as a country that issues the world’s major currency. The U.S. must think about and strive for global economic stability and development.

As a major developing country, China’s government has always maintained a responsible attitude. From now on, China will continue to implement practical policies and measures to increase domestic demand and promote consumer spending. China will also work diligently in areas such as social security, medical care, education, housing, and other matters affecting the people’s lives. China will steadily promote market reforms regarding resource prices and exchange rates and put in a great effort toward changing the pattern of economic development, adjusting the economy’s structure and making China’s economic development rely more on domestic demand and less on exports. Through its own hard work, China will contribute toward promoting global economic balance and development.