Changes in China's Financial Sector After the Global Financial Crisis: Focusing on the Impact on China-US Relations

EAI China Panel Report No. 6

Author

Seo Bong-kyo (徐逢敎)_Professor of Chinese Language and Literature, Dongduk Women's University (specializing in Chinese economy and finance). Earned a Ph.D. in Economics from Seoul National University. Previously served as a Senior Researcher at the Overseas Business Research Team, Samsung Financial Research Institute (specializing in Chinese finance), and as a Senior Researcher at LG Economic Research Institute (specializing in the Chinese economy).

I. Introduction

Amidst the global financial crisis triggered by the U.S. subprime mortgage crisis, China faced a domestic and international political-economic environment that differed from the past. Prior to the crisis, China had sustained stable and high economic growth by adopting an export-led economic growth model. However, it faced a situation where the "global imbalance," the driving force behind this growth, was becoming unsustainable.

In the changed global economic environment after the crisis, the changes in the economic relationship between the United States and China are a particularly important issue, given their ripple effects on the global economy. After the financial crisis, China became the engine of global economic growth by overcoming the crisis faster than any other country, and the reduction of the U.S. role and the expansion of China's role became a matter of great interest to many people worldwide. The future evolution of the economic relationship between these two countries will be a decisive factor in the restructuring of the global economic order. However, the economic relationship between the U.S. and China is complex: while it has become closer and its economic importance has expanded in some aspects following the global financial crisis, it has also shown signs of intensifying conflict in others, such as the renminbi issue, making it very difficult to forecast future trends.

This paper aims to analyze the changed economic environments of China and the U.S. after the global financial crisis, focusing specifically on the financial sector within their economic relationship, examine the economic policies implemented in response, and forecast future trends based on this analysis. To this end, the financial sector will be broadly divided into the macro-financial sector, including foreign exchange and monetary policy, and the micro-financial sector, related to the business activities of financial institutions. This division into macro and micro aspects is advantageous for understanding and interpreting phenomena where internal cooperation may be forming or vice versa, even as China and the U.S. appear to be in increasingly confrontational relations on the surface.

II. Changes in the Macroeconomic Aspect

1. The Relationship Between the Financial Crisis and Global Imbalances

Prior to the crisis, China's economic growth model was fundamentally an "export-led growth" model. The Chinese government pursued this model by artificially lowering the prices of production factors, such as land, and implementing policies favorable to exports, leveraging its abundant low-wage labor force. To address domestic economic problems that had severely stagnated after the Tiananmen Square incident in the late 1980s, the Chinese government actively integrated into the international division of labor system in the 1990s, focusing on job creation through export expansion (Steinfeld 2011). In 1994, reforms were undertaken to establish a unified exchange rate system, which included a significant devaluation of the official renminbi exchange rate, to boost exports. Various institutional reforms were also pursued to attract multinational corporations seeking to utilize China as a manufacturing base. Particularly after joining the WTO in 2001, China's exports grew rapidly, far exceeding the economic growth rate, thus driving China's growth. The contribution of exports to growth even reached 20% in the 2000s.

[Figure 1] China's Growth Rate and Export Growth Rate Trends (Unit: %)

Source: Statistical Yearbook

Exports from China to developed countries such as the United States and Europe account for a significant portion of its total exports. Exports to the United States reach 20% of total exports, and considering that a substantial portion of exports to Hong Kong (around 15%) are re-exported to the United States and Europe, China's export dependence on developed countries was considerably high. The reason for this high dependence on exports to developed countries was the international economic environment created since the 1990s, which aimed to balance "global imbalances." Based on low labor costs and an undervalued yuan exchange rate, China was able to expand exports to developed countries, including the United States, and secured a large amount of dollars through trade surpluses with the United States. In contrast, the United States could suppress inflation with inexpensive "Made in China" products and lead economic growth through expansionary fiscal policies, as China continuously purchased U.S. Treasury bonds.

However, after the 2008 global financial crisis, this export-driven growth model of China began to face limitations. This is because the major export destinations, the U.S. and European markets, experienced severe economic downturns due to the impact of the global financial crisis. Consequently, China's exports sharply declined after the global financial crisis, and the contribution of net exports to economic growth fell to -40.6% in 2009. Furthermore, the dollar recycling structure (a structure where dollars flowing out due to the U.S.'s current account deficit flow back into the U.S. through investment in U.S. financial assets by current account surplus countries) that enabled global imbalances faced a situation where it was difficult to sustain as foreign investors' confidence in the U.S. economy weakened.

[Table 1] Gross Domestic Product (GDP) and Export Dependence of Major World Economies

Source: KOSIS

2. Macro-Financial Cooperation Between China and the U.S. Immediately After the Crisis

In the immediate aftermath of the global financial crisis, China and the United States demonstrated a significant level of cooperation in the macro-financial sector to overcome the immediate crisis. This cooperation was evident in two main aspects: first, the implementation of expansionary monetary policies in sync with global stimulus measures, and second, the adjustment of the pace of yuan appreciation.

Following the global financial crisis, as expansionary monetary policies were implemented worldwide to alleviate global credit crunch and stimulate the economy, China also pursued expansionary monetary policies and large-scale economic stimulus measures. This represented a complete overhaul of China's existing tight monetary policy. Since 2006, China had adopted a "dual-pronged" (쌍방, ssangbang) policy to curb overheating and inflation, and began rapidly increasing deposit and lending rates starting in 2006. The deposit rate, for instance, was raised from 2.25% to 4.14% by December 2007. This was because economic growth rates of 12.7% and 14.2% in 2006 and 2007, respectively, showed signs of overheating, and consumer price inflation also began to rise to the 4% level.

However, by July 2008, when the financial crisis intensified, the economic policy stance shifted to "maintaining growth and controlling inflation" (一保一控, il-bo-il-kong), and by October 2008, it changed again to "maintaining growth." At the State Council executive meeting in November 2008, it was decided to transition fiscal policy from prudent to proactive and monetary policy from overall tightening to "appropriate looseness" (이장규 외 2010). Consequently, bank interest rates began to be lowered, and by December 2008, they were reduced back to the pre-2006 level of 2.25%. In addition to interest rate adjustments, stimulus policies for large-scale domestic demand expansion were pursued, and the money supply (M2) also increased rapidly... (continued)