Author: Tomas Freitas
This Paper has been prepared in response to Christine Lagarde the Managing director of International Monetary Fund during International Finance Forum in Beijing 9 of November 2011. Please read the IMF intervention on this link: https://www.imf.org/external/np/speeches/2011/110911.htm
After the global financial crises has been affected global economy. The phenomenon has started again and at this time smashed Europe’s which includes; Portugal, Spain, and Italy and Greece. The question is why these defaults repeatedly appeared in capitalism modern society?
In contrast to Europe’s crises, Mrs Lagarde has congratulated China, because “fundamentally, China is on the right path”, however at the same time she also warned that global and regional economy is under the “dark clouds”. In her speech, she has highlighted fourth points which she thinks very important to guarding global economy governance (IMF, 2011), and
the points are; ‘Global and regional economic challenges, ‘Policy path’, ‘The Role of China’, and ‘Global economic governance’, (IMF, 2011). This essay will analyse her speech at the four points. The paper also will try to identify some logic of the argument in related to country risk.
Growth and Crises
China Gross Domestic Products (GDP) have grown ten percent in average in the last decade, however, if we compare in the last three decades, the data have show us that GDP rates has rise up and down, and unemployment rates gradually increase fewer than five percent.
Table 1. China GDP and Unemployment rates
The GDP above has reflected political and financial estability. In the late 1970s, after the death of Mao Zedong in 1976, the GPD growth has fallen down from 11.7% in 1978 to 7.8% in 1980, (World Bank,2012). And the total unemployment rate in 1978 was 5.3% (ILO,2012). This is the begining of Deng Xiaoping economic reform which has bring fresh air to private sector development in China by replacing collective and state land ownership (Han & Pannell, 1999). This land policies reform also has affected grain production in China, (Rozelle, et al, 1997).
In 1988-1990 the GDP rates also felt which caused by adoptation of new plan called “New Order for the Socialist Commodity Economy” The Secretary General of Chinesse Communist Party (CCP) Zhao Ziyang has took advantage of Deng Xiaoping leadership. Zhaos had brought new plan which introduced dissengagedment of the state in to price control and promote export by devaluing the currency, (Dittmer, 1990). However, according to James Dorn & Wang Xi (1990), the aim of the plan is to achieve Macro-Market which is deliberately by the state.
In 1998, the GDP rates has declining, the Asian crisis has affected China. However, the Chinesse government has prepared effectively in response to the crisis, starting by not devaluing their currency, consolidate national banking and as well as apply ‘accounting reform’ in order to standarizing accounting practices, which Chinese government believed that they can avoid ‘financial bubble’ by detecting instability in financial markets (Lin & Chen, 2000).
In 2008 global financial crisis (GFC) has erupted, Chinesse scholar believe that the impact of GFC in China economy because of the reduction in the global demand of China exports and imports (Yu, 2010). Chinesse government has apply three levels of action in order to anticipate next global recession. And those are; Internationalising local currency Renmimbi (RMB), Regional monetary cooperation in East Asia and Reconstruction of international monetary regime. Chinesse government seems very anthusiastic in internationalising their local currency, they believes by swaps Chinesse RMB with other currencies through bilateral agreetment, it will help the countries easily to purchase China’s goods and products, (Zhang, 2009).
The historical above will help us to understand the current development of China economy in rebalance the global economy.
Global and regional economic challenges
In Mrs Lagarde (2011) first point, she have deeply concern about the global economy which she thinks has cross the thresholded of insecurity, she worried about the ultrapassing of financial sector beyong the real economy, which might cost more unemployment. Her bigest worries as quoted below:
“If we do not act, and act together, we could enter a downward spiral of uncertainty, financial instability, and a collapse in global demand. Ultimately, we could face a lost decade of low growth and high unemployment”... “Asia is not immune, however, from developments in the rest of the world. The trade channel is critical, as the region still relies a lot on external demand to propel growth. Emerging Asia is also vulnerable to developments in the financial sector” (IMF, 2011).
The statement above can be defined as ‘cross-border risk to profitability of foreign investment’, because as second large exporter and third large importer in the world (Torres, 2011), foreign investors has play very crucial role in pumping China economy, with the advantage of high population and less labour cost, the investors has making profits by utilising cheaper labour power for assembly their products, (Foster & McChesney, 2012).
According to Deutsche Bank Research institute, that in the last ten years China financial market has moving up to 13%, which composed by 16% of stock market and 5% of bonds market, (Hansakul et al, 2009). However, living with the reality as second large exporter and third large importer in the world, China economy still classify as real economy because based on production of goods and services rather than financial speculative (Knight 2011).
If we apply the theory of elasticities approaches, with the relative price effects to analysing supply and demand of exports and imports, will China survive for the next crisis? Considering second and third large exports and imports in the world, it looks like China already moves in to internationalising their local currency Renmimbi (RMB) by bilateral swaps with the regional cooperation and cross border trade settlements. According to the theory of elasticities approaches;
“Foreign exchange can be obtained exclusively by exporting and the only need for foreign exchange is to pay for imports. When disequilibrium occurs, the goal of devaluation is to bring the supply and demand of foreign exchange into equilibrium” (Bouchet et al, 2003, 32).
In this case China already move beyond the theory above, which is does not needs to devaluing their currency for the equilibrium, because through bilateral swaps agreement, the exchange rates has been set by each central banks. Moreover, the bilateral swap agreement between china and their countries partner, has decided that the RMB cannot be use currently by those countries to intervene foreign exchange markets, (Zhang, 2009).
Her second though, is the intervention in fiscal and monetary policies which is aiming stability and growth. Ironically, the IMF has forgotten many times that they have spoken about strengthening financial regulation, and pushed their agenda in to internal country fiscal and monetary policy. Sadly there are no lessons, and outcomes from IMF, since the crises occurred in; Asia, US, Iceland, Spain, Portugal, Italy, Greece. Let’s have a look an interview below with former managing director of IMF Mr. Dominique Strauss-Kahn about the sub-prime mortgage crisis in the US.
“Q: Mr. Strauss-Kahn, the U.S. financial system is close to collapsing. Banks are being nationalized and taxpayers are expected to bail out Wall Street with billions. Is this the end of the free market economy?
A: Not at all. I believe that the market economy will emerge strengthened from this crisis. The free market economy needs regulations, a framework to function, and as soon as the immediate danger of a systemic crisis is over, new regulations will strengthen the financial system and thereby the market economy, and reduce the risks of market failures”, (IMF, 2008).
And please have a look the quoted below, the advice from Mrs Lagarde in the case of solving financial crisis in Greece;
“As I said, I am encouraged that on October 26, Euro Area leaders agreed on a framework that would restore debt sustainability in Greece; recapitalize European banks; strengthen the firewall against financial contagion; and lay the foundations for robust economic governance in the euro area”, (IMF, 2011).
Those statement above has indicates that, the IMF still working on ‘new regulation’ which might be will strengthen the financial system in the future, and at the moment only one treatment that IMF can propose for financial recovery and that is ‘financial surgery’, or ‘loans with the conditionality’ in other words they called ‘debt sustainability’, etc.
In this second though, financial contagion can be approaches by investors and government, because fiscal and monetary regulation, as well as portfolios has relation to banking, which is can state reserve bank or private banks. In this case the risk can be relying on credit risk and sovereign risk.
The role of China
The third point, she has proudly applause to China, because in three decades still ‘on the right path’, and off course the right path of free market orientation. However, she also has mentioned that;
“Now is the time to move further from exports and investment toward consumption,” (IMF, 2011).
This means China households consumption needs to be increase in order to balance the growth. According to the editor of Monthly Review, John Bellamy Foster and Robert McChesney (2012), the ability of local consumers in China are decreasing, since the period of 2002 – 2008; it’s about ten percent lost.
If the GDP = C + I + G + Xn , as mentioned by Foster and McChesney (2012), that China consumption has gradually decrease, but is that matter with the GDP? The fact is the consumption are lower, the investment are high, the government spending relative steady, and the net of exports and imports are increase, China GDP still relative safe. The point is with the big population, lower wages it will affected households consumption.
Global economic governance
The last point, she has highlighted that China sit on the top three of IMF membership because of structure reform that the organisation has applied. Please have a look the graphic below.
We cannot judges the economy growth based on one decade only, at least two or three decades, and that can provide us strong and deeply analysis to understanding the context. Change in leaderships it always vulnerable to adaptation of new ideology, and if the new ideology did not match with the country characteristic, normally it can be survived but not grounded. Because has been survived for more than three decades, sometimes people think maybe this is a good model for the others to follow. Some people preferring the outcome instead than the process. Some people proudly with the ten percent growth and some people, some time miss interpreted of how can be that is ten percent.
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