An Analysis of The Effects of the Financial Crisis and Its follow-up events on China and United States and the reactions of both countries
Ruichen,Wang
University of Illinois, Urbana-Champaign

Introduction The recent economic world has been focusing on the Financial Crisis started in 2007 for a long time. It is considered as the worst financial crisis since the Great Depression of the 1930s by many economists and its impact spreads through all the continents except Antarctica (Reuters, 2009).There is no final assertion about if the crisis has ended, but it is still important for us to understand the economic knowledge about it. As the two largest economies in the world, China and United States are the most suitable examples for us to analyze (International monetary Fund, 2011). The reactions of the two involve various macroeconomic theories which are worth our attention. The interactions between the two make us better understand the two economy model and allow us to apply it in more events in the future. What is the most crucial is that the analysis of the Crisis will help us avoid such tragedies in the future. In this essay, this issue will be divided into the 11 parts and will be carefully analyzed. Through detailed narrations of background information, careful analysis of the government policies during the Crisis and their results, and objective comparison of these policies, an assertion of how to avoid and deal with future recessions have been achieved stating that The Economic Background before the Financial Crisis in China China is one of members of the BRICS, an unofficial name for the five developing countries-China, Brazil, South Africa, Russia and India- which are expected to become the top economies in the future (SouthAfrica.info). After the 1979 Economy Reform, China has experienced almost 30 years incredibly high-speed increase in its real GDP. During 1979-2007, the average speed of real GDP growth is 9.8 percent. Such a growth rate became extraordinarily high after 2003. In the period of 2003 to 2007, the average Real GDP growth rate was 10.6 percent (Liu, 2009). China has already one of the largest economies in the world; however, its per capital GDP is very low, making it still a developing country. (International monetary Fund, 2011)China is a country whose economy depends pretty much on exports. In 2006, the net export of China is 1665.41 billion RMB, which made up around 7.5 percent of China’s GDP (Xie, 2007). To be more specific, according to Liu, ten percent of export growth would result in one percent of real GDP growth in China (Liu, 2009). The position of export in China’s economy is actually far more important than such stats show because export industries in China are labor intense industry which contributes a lot to the China’s employment rate. The difference in China and US economic system are mainly revealed in the following aspects. The most important economic difference between China and United States is the economy system. China is currently operating on ‘socialist market economy with Chinese characteristics’ (Lorenz & Wagner, 2007). It is a kind of special economy system which admits the priority of capitalist economy, which most nations in contemporary world belongs to, while still remain several composition part of socialist economy including state-owned enterprise and strong government intervention. Another unique trait that China has is the unbalance of development between the eastern coastal areas and western parts. To be more specific, in 2006, Jiangsu, an eastern province of China, had a GDP of 2164.508 billion RMB, while Qinghai, a western one, only had a GDP of 64.158 billion RMB (Xie, 2007). Last but not least, the decision making of the central bank of China, People’s bank of China, is directly controlled by the government. The economic condition in United States will be discussed in the following paragraph.

The Economic Background before the Financial Crisis in United States United States has been the world largest economy since around 1880 (Walker, 2007). The Gross Domestic Product in United States before 2007, the year when Financial Crisis started, was 13377.2 billion dollars, which exceeds the sum of the two following economies, China and Japan (International monetary Fund, 2011). The economy of United States has been in a relatively stable growth period of 2 to 3percent annually since 2000, while in 2001 it experienced a weak growth of only 1 percent because of the effect of dotcom stock crisis (International monetary Fund, 2011). It is commonly accepted that United States has huge influence on the world’s economy. One example that perfectly exemplifies such an idea is that the New York Stock Exchange is world largest stock exchange by market capitalization of its listed companies at about US$23 trillion in February 2012 ("WFE：world federation of," ) . The United States has an economy system of capitalist, which is different, or almost opposite of China’s economy system. Unlike China, the central bank of the United States, the Fed, although functions as a money printer and a monitor and corrector of macroeconomics like other central banks, it is a relatively independent agency which means it might disagree with the government (Gottheil, 2009). Also, the regional economic development of United States is unbalanced, but not as unbalanced as China does. Such characteristics result in the different government policies between China and United States when facing the Financial Crisis.

The Cause of the 2008 Financial Crisis in US The happen of the 2008 Financial Crisis is a perfect example of recession period in the business cycle model. Tracing the cause of 2008 Financial Crisis, we can retrospect to a mild and short-lived recession in US in 2001 (Singh, 2009). When facing such a recession period, what the central bank should do is to increase the aggregate expenditure. When aggregate expenditure increases, the nation’s national income would increase as well because of the effect of income multiplier. Methods of stimulating aggregate expenditures includes tax-cut, lowering of interest rate, etc. (Gottheil, 2009). In 2001 the Fed lowered the Federal Funds Rate in order to make the interest rate fall. In fact, the Federal Reserve lowered the Federal funds rate 11 times - from 6.5% in May 2000 to 1.75% in December 2001 (Singh, 2009). In fact, the Fed achieves such a goal by operating open market operation, which is mainly buying back government securities (Gottheil, 2009). Such an act gave the banks incentives to make loans to individuals and businesses because even if when the banks are running out of excess reserve, the cost of borrowing money from other bank is low enough to make quiet considerable profit. At the same time the housing price kept going up in the US, which made mortgage a prior option among different kinds of loans (Singh, 2009). The bankers, in order to achieve profit, provide low interest rate together with different kinds of exotic or non-standard mortgages including the adjustable rate mortgage (Bernanke, 2012). Borrowers have no reasons to reject such low-interest loans which made their dream of having a house possible. At the same time, banks made little effort on monitoring and evaluating the borrowers’ credit, because it is obvious that the increasing housing price made it possible for banks to prevent loss by confiscating the houses when the borrowers couldn’t repay their loans. However, the banks don’t keep all the mortgages in balance. According to Bernanke, many of those exotic or subprime mortgages were sold to government sponsored enterprises, such as Fannie Mae and Freddie Mac. Those GSE packed these mortgages to make mortgage-backed securities, which is called ‘securitization’ (Bernanke, 2012). There were also insurance companies like AIG who backed up these securities by providing coverage insurance (Bernanke, 2012). Strong faiths in government together with the safety brought by the insurance made people believe that these securities are so reliable. No one can reject low-risk investment. Therefore, so many investors purchased these MBS while even GSE like Fannie Mae and Freddie Mac kept large amount of these securities in account (Bernanke, 2012). Unfortunately, in 2004, the US homeownership peaked at 70percent (Singh, 2009). The decrease in demand together with a constant supply made the price level decreases. In fact, “during the last quarter of 2005, home prices started to fall, which led to a 40% decline in the U.S. Home Construction Index during 2006” (Singh, 2009). The fall in housing price make the houses worth less than the mortgage amount. So many subprime borrowers decided to give up the house and stop repaying the mortgage. Also, because many long-term adjustable rate mortgages have higher interest rate as more years pass, it is unable for many subprime borrowers to repay those mortgages (Bernanke, 2012). Actually the initial loss was not so bad. According to Bernanke, such a loss equaled to “the size of one bad day at the stock market” (Bernanke, 2012). What really made the situations worse was that those securities were purchase by quite wide range of investors including financial firms and individuals. The panic interfered the financial market by disenabling the short-term funding such as commercial papers because of the incredibility between each other in the financial market (Bernanke, 2012). Soon such pressure made many giants fall, including Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, AIG, Washington Mutual, etc. (Bernanke, 2012). The fall of these giants marked the peak of the Financial Crisis. At the same time, the Crisis spread to the whole world because international holders of securities suffered loss, trade partners of US was negatively affected and international financial transactions were threatened.
The Cause of the 2008 Financial Crisis in China In China, the Cause of the 2008 Financial Crisis was simply the aftershock and negative effect brought about the Crisis happened in United States. As I mentioned before, China is an economy that rely pretty much on its export. Among all the country it trades with, United States is the one that accept most exports. According to National Bureau of Statistics of China, in 2008, the export from China to the US was 252,383,550,000 dollars, made up around 17.6percent of its total export (Ma, 2009). The Financial Crisis in United States caused a 3.5 percent decline in The US’s real GDP and thus led to a continuous increase in unemployment rate peaked at 10 percent ("Bea national economic," ;"Bureau of labor," ). These events definitely decreased the personal consumption spending of the US since its national income decreased. The decrease in the US personal consumption spending would result in a decrease in the US’s import of Chinese goods. In fact, the import of US from China decreased from 252,383,550,000 dollars to 220,802,220,000dollars (Ma, 2010). At the same time, because the mortgage-backed securities were hold by many countries all around the world, the disturbance in the financial market spread to other countries other than the US, making the national incomes of many countries decreased as well. Such deduction perfectly fit the statistics of the international monetary fund, showing that almost all the countries experienced a recession during 2008-2009 (International monetary Fund, 2011). The world-wide recession after the US crisis made China suffer more. In fact, its total export decreased from 1430693070000 dollars in 2008 to 1201611810000dollars in 2009 (Ma, 2010). Simultaneously, the recession also caused international investors to cut down investment abroad. According to National Bureau of Statistics of China, the total amount of foreign investment diminished from 95.253 billion dollars to 91.804 billion dollars (Ma, 2010). The decrease in export and the run-out of foreign investment led to the bankruptcies of many small or middle sized manufacture firms in China. It is shown in the
The Reaction of United States and the Result
The Reaction of China and the Result
The Interaction between China and United States Government
The Comparison and Analysis of China and United States’ policies
Conclusion

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