The world had undergone cyclical global financial crises in the last few decades. There were many reasons behind these crises that have many dimensions and causes.
First, U.S sub-prime mortgages were the main cause that the global financial crisis was attributed. This was a result of lending in excessive manner by U.S banks. The banks did not take a careful analysis of the creditworthiness of the customers and this in turn led to unhealthy credit expansion. The asset prices also were first rising (three times faster than family income at the national level, Duncan, 2005) but later on started a deep decline because property prices can not continue longer and it is hard to maintain asset price bubble. Consequently, the consumption, which previously exceeded the output due to the low interest rates, has fallen. (Duncan, 2005)
One more important issue that deserves mentioning is that mortgage originators collateralized their debt. The collateralized debt (CDOs) was sold and hence the complete risk of default was transferred to the absolute buyer. As a result, several U.S banks were bankrupt (Such as Lehman Brothers in 2008) or the U.S government bailed out them (Like AIG). The end results were credit crunch and debt crises. It was hard for even healthy banks to obtain sources of financing due to a breakdown of trust among banks. ( P.K Abdul Ghafour, 2008. Arab News). Adversely, the losses and capital write-offs affected the banks and financial institutions in the advanced countries. (Mohan 2009)
Therefore, the impact of global financial crises were tremendous including debt crises and credit crunch, crisis in global financial markets, an extremely risk aversion, the huge losses of banks and financial institutions, the rising of commodity prices levels and their subsequent collapse.
Second, persistent and substantial increase in U.S current account deficits in contrast to the substantial surpluses in Asia, Middle East and Russia caused global imbalances. There were also saving and investment imbalances that led to a huge capital flow (both inflow and flight). This has put pressure on financial intermediaries (banks). (Mohan 2009) The surplus countries experienced capital inflow that led to asset price bubbles. The inflow was caused by the excessively loose monetary policies in United States and low interest rates.
Third, unstable financial system, failure of regulation of banks, and liberalization of financial markets were among the causes of the global financial crisis.
Impact of the Global Financial Crisis on China and Other Asian Economies
Asian financial crisis started in Thailand and then spread to other Asian countries like Indonesia, Korea, Malaysia and Philippines. The major cause of the crisis was due a currency problem. There was an extreme financial distress felt by financial institutions and corporations with foreign-currency debts because of a massive depreciation of local currencies. The Asian countries went deep into a recession and there were large capital losses in emerging market-securities for foreign investors from the developed countries.
Weak domestic financial system was supported the currency crisis.
The capital markets were liberalized and free capital flows across the orders were allowed. Therefore, the firms and financial institutions borrowed heavily from U.S and Europe. This liberalization of capital markets and freedom of capital movement resulted in credit boom in Asian countries. Both borrowers and lenders were encouraged by the fixed exchange rate not to hedge the financial transactions and to take excessive risks. There were poor risk management, poor supervision and lending decisions based on political considerations that resulted in improper allocation of resources.
Consequently, the economic boom characterized by fixed exchange rate appreciated the real exchange rate, meaning that the growth of Asian exports slow down.
The credit boom changed into credit crunch. The investors withdrew their capital and rejected to renew the short-term loans. This hurt the creditworthy and marginal borrowers.
On the other hand, China is one of the World's advanced economies and export-oriented country. Actually, it was in 2008 when "China has become the 3rd largest economy, the 2nd largest trading nation, and the largest foreign exchange reserve holding country in the world". (Yu Yongding, 2009)
The problems created by the credit boom and subsequent trade imbalances with U.S have inflicted China severe negative effects to its currency, foreign reserves and capital inflows.
Appreciation of Yuan against the dollar has caused the demand for china products to fall. The export growth of china dropped dramatically from 29% of the GDP to -25.7% in Feb 2009. Therefore, we can imagine how great the impact on the growth is.
The depreciation and devaluation of dollar also reduced the value of china's foreign reserves which is two trillion in USD and one trillion in USD assets (mainly treasuries). It is said that China already has fallen into a dollar trap.
Capital flow has its impact on investments in this region in general and china in particular. Pulling out of funds from Asian banks and investing them back in US and Europe are what happened during the Asian crisis.
China's Currency Swap and Its Impact on Trade of Participating Countries
As China has expressed its concern about the U.S. dollar's weakness, a regional cooperation to avoid repetition of financial crisis in the event of global financial crisis was the Asian countries' focus. In light with that, china signed bilateral agreements with several Asian and non-Asian countries in other continents. These countries include Malaysia, Indonesia, South Korea, Hong Kong, Belarus and Argentina. The swaps, lasting three years, totaled 650 billion Yuan ($95.1billion). The objectives of these swaps agreement include achieving financial stability, economic development, meeting liquidity needs, hedging against exchange rate risk, promotion of bilateral trade. (Tina Wang, 2009. Forbes, Xinhua, Jan. 20, Feb. 08, 2009).
Other objectives of the swap agreement as the central bank of china remarked also include avoiding importers to pay the Chinese products with US dollar. The importers can directly buy the Chinese goods and pay using Yuan.
According to Joseph Yam (The monetary Authority of Hong Kong Chief Executive), such agreements will "contribute to the development of a mutually assisting, complementary and interactive relationship between the financial systems". (Xinhua, Jan. 20, 2009)
Some officials are not optimistic to the effect of Yuan in these arrangements of these bilateral swaps. Their justification is that Yuan is not fully convertible yet and hence there is a long way to go until the impact of these agreements can be felt. However, they expected in the long-term that there will be a broader use or internationalization of Yuan promoted by the China's strategic economic and political interest.
If the above-mentioned objectives can be achieved depends on how these countries cooperate. Economic development will be expected if the results are obtained through take and give trading activities. The important factors that promote such cooperation are that these countries share common concerns such as USD as a medium of exchange, sources of raw materials for production and contagious effect that comes from other financial systems in the advanced economies in the world.
