China and the Global Financial Crisis

GENEVA – Is China an island of stability in the midst of the gathering global financial storm, or will it, too, soon be sucked into the vortex?

Chinese officials have said that the crisis that began in the United States will not slow down long-planned reforms in China’s financial markets. They insist that China will go ahead with plans to introduce margin trading, short selling, and futures contracts on share prices. But China slowed capital-account liberalization after the Asian financial crisis ten years ago, so it is possible that America’s troubles could make China more cautious.

China has played an important role in financing the US budget deficit in recent years, thanks to its effort to manage the renminbi’s exchange rate against the dollar. China does not want its large current-account surplus to cause the currency to overshoot on the upside, and it may now want to slow the renminbi’s appreciation because of concern about the global economic slowdown.

If so, China would have to expand its foreign exchange reserves by another $300-400 billion, which would allow it to finance the large expansion in the US fiscal deficit.  Recent slight declines in the value of the renminbi suggest that China’s exchange rate policy may be changing following its 20% appreciation of the currency since July 2005.