Global financial crisis and its impact on ChinaBUSI 3001 SBLCWeek 3(2), Spring 2010

Charles Mo & CompanyMarch 8, 2010

Global financial crisis and its impact on China Background

Chain of events leading to the global financial crisis Definition of recession and depression

What caused the global financial crisis? Housing bubble Sub prime crisis Mortgage lender collapse Investment bank collapse Bank collapse Worsening unemployment Auto industry trouble Christmas retail sales disaster

Income gap in US as a result of the financial crisis How will the Feds exit after the massive government bailout? Impact on China from the global financial crisis

Paulson’s report Current economic situation

Abbreviation

Date Events Victim Bailout sponsorCost in billion

   

January 22, 2008Feds cut interest rate by 75 percentage basis, largest since October, 1984 to 3.5%.  

 February 11, 2008 Bush Stimulus Package  167

March 16, 2008Feds step in and intervened. JP Morgan Chase acquired Bear Stearns for $2 a share for 236 million Bear Stearns

JP Morgan and Treasury 67

   

March 18, 2008 Cut interest 75 base point to 2.25%  

   

July 14, 2008 Announced to assist FREDDIE and FANNIE Federal Reserves  

   

September 7, 2008Treasury nationalized the two largest mortgage companies in the housing industry FREDDIE Treasury 15

   

 Treasury nationalized the two largest mortgage companies in the housing industry FANNIE Treasury

15

   

September 15, 2008 Bank of America to acquire Merrill Merrill Lynch Bank of America 50

   

September 15, 2008 185 year old Lehman Brothers filed for bankruptcy Lehman Brothers None 0

   

September 17, 2008 Treasury nationalize AIG AIG Treasury 85

 September 29 DOW dropped 700 points to 10371  

October 3, 2008 Emergency Economic Stabilization Act of 2008 Americans Congress 700

   

December 16, 2008 Interest cut to 0.25% Feds  

February 17, 2009 Obama signed the $787 billion stimulus plan, an ambitious package of federal spending and tax cuts designed to revive the economy and save millions of jobs.

February 26, 2009 Thursday Reaganomics era ended and Obamanomics just started

Direction is Center to left 3.6 trillion budget Great expansion in government activism Tax increases on affluent and business Spending cut on those profited from “an era of profound irresponsibility” National health care Shift energy away from oil and gas Commitment to education To fund it

End Iraq war 13,500 more tax if you make 250k 6,000 more if you make 200k 800 less if you make 70k or less Business tax increase

Creates a budget deficit of 1.75 trillion for fiscal 2009, 12.3% of GDP, not seen since 1942

Recession is the economy shrinking for two consecutive quarters (=6 months) with adecrease in the GDP (=Gross Domestic Product)

GDP = Value of all the reported goods and services produced by the people operating in the country

What is Recession?

GDP = MONEY VALUE OF {C + I + G + (X – M)}

C = Consumables, I = Gross Investments, G = Government Spending, X = Exports, M = Imports

Depression Long-term downturn in economic activity More severe downturn than a recession that is part of a normal

business cycle Considered a rare and extreme form of recession Elements of Depression

a depression is characterized by its length, and by abnormal increases in unemployment, falls in the availability of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly

devaluations. Price deflation, financial crisis and bank failures

1) a decline in real GDP exceeding 10%, or 2) a recession lasting 2 or more years.

US Unemployment Rate

Failed FDIC insured banks 2008 25 2009 140 February 6, 2010 16

Economic Crisis 2008

Housing Bubble/ Market Collapse Sub prime loan crisis Mortgage lenders collapse Investment banks collapse Banks collapse Unemployment rate continue to climb Auto industry trouble Christmas retail sales disaster

The Housing Bubble Housing Bubble 1 – Housing bubble formation Housing Bubble 2 – Sub prime mortgage crisis Housing Buddle 3 – Mortgage backed Securities

Different Mortgages Prime Mortgage Jumbo Mortgage (loan amount over $417,000) Near Prime Mortgage Sub Prime Mortgage

Mortgage Lenders Collapse Countrywide Washington Mutual Wachovia Bank United Franklin Financial H&R Block Mortgage Lone Star Mortgage

Sub prime problem Sub prime loan lent to sub prime borrower usually ARM

(Adjusted Rate Mortgage) Lender (bank or mortgage co) bundled them and issued

RMBS (Real-Estate Mortgage Backed Security) RMBS backed by GSE (Government Sponsored

Enterprise) or guaranteed by CDO’s (Collateralized Debt Obligation) were sold to investors

Bear Stearns, Lehman, AIG buy and own sub prime securities

AIG issues insurance to guarantee sub prime mortgages

Sequent of events in Sub Prime Money flown into the sector Mortgage lenders Hedge Fund Venture/private equity Investment Bankers GSE Commercial banks Insurance companies

Investment Banks Collapse Bear Stearns Intervened Lehman Brothers bankrupt Merrill Lynch Acquired Morgan Stanley changed to Commercial Goldman Sachs changed to Commercial Five largest investment bankers disappeared since

the creation of the Glass-Steagall Act of 1933 , repealed in 1999

Banks collapse

Washington Mutual Indymac Bank Security Pacific 25 failed in 2008 140 failed in 2009 15 banks failed as of March 2, 2010

WSJ 09-11-09 p23US Debt Guarantee Fades

Temporary Liquidity Guarantee Program – a FDIC guarantee for the banks to issue debts

The initial fees charged by the FDIC was 0.75% Program originally ends October 31, 2009. Now extended to June

30, 2010 As of September 4, outstanding TLGP guarantee totaled 304 billion Two biggest users are GE and Citigroup, followed by GMAC How does it work? If any banks need to continue participation, fees at 3.0%

Acronym/Term

ARM = Adjusted Rate Mortgage RMBS = Residential Mortgage Backed Securities GSE = Government Sponsored Enterprises,

FANNIE MAE, FREDDIE MAC, GINNIE MAE CDO=Collateralized Debt Obligations SEPA= State Environmental Protection Agency

Auto Industry Decline

US Auto sales numbers for January, 2009:

General Motors plunged 49 percent

Ford's sales dropped 40 percent

Toyota's sales dove 32 percent

Nissan's dropped 30 percent

Honda's fell 28 percent

But Subaru for a second month in a row, posting an 8 percent sales increase

Hyundai sales jumped 14 percent.

Treasury Secretary Timothy F. Geithner- a 2008 Acura TSX. Owned a 1999 Honda

Accord and a 2002 Acura MDX, according to public records.

Lawrence Summers- 1995 Mazda Protege. Peviously owned a 1996 Ford Taurus GL.

Office of Management and Budget Dir. Peter Orszag-a 2008 Honda Odyssey and a

2004 Volvo S60. Previously owned a 1997 J eep Grand Cherokee and 1982 Datsun.

Carol Browner, the White House climate czar. Public records a 1999 Saab 9-5 SE.

Energy Secretary Steven Chu doesn't own a car.

EPA Administrator Lisa J ackson- 2008 Toyota Prius and a Honda Odyssey minivan.

No information for Transportation Secretary Ray LaHood or Christine Romer, head of

the Council of Economic Advisers.

Here's what task force policy aides drive:

Austan Goolsbee, staff director and chief economist for the White House Economic

Recovery Advisory Board, owns a 2004 Toyota Highlander.

J oan DeBoer, the chief of staff to LaHood, drives a 2008 Lexus RX 350.

Heather Zichal, deputy director of the White House Office of Energy and Climate

Change, owns a Volvo C30, according to public records and officials.

Gene Sperling, counsel to the Treasury Secretary, owns a 2003 Lincoln LS, and

previously owned a 1993 Saturn SL2.

Edward B. Montgomery, senior adviser to the Labor Department, owns a 1991

Harley-Davidson and previously owned a 1990 Ford Taurus L station wagon.

Lisa Heinzerling, senior climate policy counsel to the head of the EPA, owns a 1998

Subaru Legacy Outback station wagon, according to her husband.

Diana Farrell, the deputy National Economic Council director, doesn't own a vehicle.

Her husband, Scott Pearson, owns a 1985 Peugeot 505 S.

Dan Utech, sr adviser to the Energy Sec, a 2003 Mini Cooper S 2-door hatchback.

Rick Wade, a senior adviser at the Commerce Department, owns a 1998 Chevrolet

Cavalier and previously owned a 1998 Toyota Corolla.

J ared Bernstein, Vice President J oe Biden's chief economist, owns a 2005 Honda

Odyssey.

Year to Year Change in Holiday Retail SalesDecember 31, 2008

Online Footwear Men’s apparel

Furniture Women’s Apparel

Electronics Luxury

-2% -14% -14% -20% -23% -27% 35%

Retail Christmas up 2.1% compared with 2008, worse than expected

WSJ 09-11-09 p14Income gap in US shrinks in slump at expense of the wealthy

In 2007, top 1% of the families accounted for 23.5% of all the income in US (UC Berkeley)

In 1929, top 1% accounted for 23.9% of all pretax income By the end of WWII, that % dropped to 13% and stayed there for 35 years Top 1% pays 36% of all federal individual income tax (Tax Policy Center, D.C.) Half of the US consumer spending in 2000 came from top 20% families Finance insurance industries account for 5.9% of total GDP in 1990 , rose to 8.1%

in 2008, estimated to slip to 7.2% this year Income gap in 1980 between the top 5% and the median is 2.86 time and rose to

3.52 in 2007 p15

How will the Feds exit after the massive government bailout?

At a late-January meeting, Federal Reserve officials signal to the market that interest rates are due to rise soon. The move catches investors off guard. Stock and bond prices plunge, while the U.S. dollar surges

A gradual tightening of the monetary policy is usually the policy of the Feds when coming out of recession

Tightening monetary policy Raising the interest rate such as, feds fund rate Raising the capital reserve ratio Purchasing the mortgages in the public such as, treasury notes, FANNIE and FREDDIE

security bonds

Effect on rate increases

US China Relations- Paulson’s Report

China emerging as a global economic power Is it a threat? or opportunity?

Threat – counter and contain Opportunity – active engagement

Why Bush/Paulson took the engagement position Recognized China’s twin priorities Trade Investment in commodity market inextricable interdependence of China's growth and that of the global economy

US China differences military modernization, Its enforcement of intellectual property rights, and its human rights record

U.S.-China Strategic Economic Dialogue (SED)

In 2006, President Bush and Chinese President Hu Jintao launched Lead by vice premier level in China and cabinet secretary level in US High level meetings twice a year recognized China's realities robust and sustained economic growth is a social imperative for China Beijing views its international interactions primarily through an

economic lens High level contact with productive relationship

Results – bilateral air service agreement in May , 2007 Passenger flights will double by 2012

Relationship is most effective through high level, cross agency approach

Decisions made in China seems to base on consensus-oriented process

Decision process

Governor of People’s Bank of China does not decide the pace of the renmenbi’s appreciation

During the second SED meeting May 2007, Ben Bernanke highlighted to 15 Chinese ministers about rebalancing China’s growth and reforming its exchange rate policy.

SEPA China’s State Environmental Protection Agency has been upgraded to the Ministry of Environmental Protection

Overlapping Interests

Growth Imbalances Income inequality Industrial sectors grow Heavy reliance on exports and investments in capital intensive manufacturing Support for energy consumption Too fast building of coastal area Current account surplus 11% of GDP Spends less than it produces High rate of savings Tight management of RMB, large trade surpluses, large capital inflow resulted a

staggering accumulation of foreign exchange reserve to 2 trillion USD

Energy security Environmental sustainability

Overlapping Interests

Trade Once the glue of US China relation, now contention China’s anti monopoly law Foreign investment Trade deficit with US 256 b in 2007, 266 b in 2008, and 233 b in 2009

Export controls

Investment issues IPR Money laundering

Product safety Lead in toys Melamine in milk, chocolate, eggs, cookies, infant formula

China’s Economy Today

Will become Asia’s largest consumer market said Commerce Minister, Chen Deming on February 23 in 12th Xiamen International Trade & Inv. Fair

World Leader in Cell phones Domestic tourism Broadband network

Second Automobiles; became first place in 2009 Gold reserve

Third Luxury items; surpassed US as second largest market in 2009

Shanghai Stock Exchange Index

Crude oil imports down 1.8%, Iron ore down 7.9% in November

In China November exports fell 2.2 % first decline since June, 2001. Contrast, October’s

19.2% gain and 26% gain in 2007 Import fell 17.9% compared 15.6% increase in October and 20% last year.

Trade with China : 2008NOTE: All figures are in millions of U.S. dollars, and not seasonally adjusted unless otherwise specified. Month Exports Imports Balance

January 2008 5,854.9 26,167.7 -20,312.8 February 2008 5,773.9 24,128.6 -18,354.7 March 2008 6,354.1 22,432.0 -16,077.9 April 2008 5,680.6 25,919.3 -20,238.6 May 2008 6,614.3 27,663.6 -21,049.4 June 2008 6,413.7 27,843.3 -21,429.6 July 2008 6,437.3 31,314.0 -24,876.8 August 2008 6,506.7 31,840.2 -25,333.5 September 2008 5,320.4 33,086.4 -27,765.9 October 2008 6,071.6 34,028.3 -27,956.7 November 2008 5,223.4 28,280.6 -23,057.2 December 2008 5,206.1 25,085.8 -19,879.7 TOTAL 71,457.1 337,789.8 -266,332.7

Year US Exports US imports US trade balance

1980 3.8 1.1 2.7

1985 3.9 3.9 0

1990 4.8 15.2 -10.4

1995 11.7 45.6 -33.8

2000 16.3 100.1 -83.8

2001 19.2 102.3 -83.1

2002 22.1 125.2 -103.1

2003 28.4 152.4 -124.0

2004 34.7 196.7 -162.0

2005 41.8 243.5 -201.6

2006 55.2 287.8 -232.5

2007 65.2 321.5 -256.3

2008 71.5 337.8 -266.3

2009 59.2 292.5 -233.3

Source: USITC

Rising US China Trade Tensionwsj16-09-09 P1, p18,p19

Rising US China trade tension threatening G20 meeting this week 35% tariff on Chinese tires for the next 3 years to preserve union jobs 17% of the tire market are imported by the Chinese Chinese tires manufacturers may loose 100,000 jobs Chinese wants to avoid wider conflict in trade More Chinese say in the IMF US sanction on Chinese steel pipe in December , 2009

What Karl Marx once said "Owners of capital will stimulate the working class

to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism“ Karl Marx, Das Kapital, 1867