By Chi Lo (auth.)
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Additional info for Asia and the Subprime Crisis: Lifting the Veil on the ‘Financial Tsunami’
However, the real impact on the economy is much bigger than expected, due to the spillover effect of trade on domestic demand. Conventional wisdom is wrong when assessing the trade impact on China’s growth. Some also fear that China might fall into a debt– deflation spiral, which would hurt its long-term economic growth and asset values in the post-subprime world. But that is unlikely, due to improvement in the Chinese banking and corporate sectors and under-leveraging in the consumer sector. Chinese banks’ subprime exposure The worsening of the US subprime crisis, as seen in the failure of the 158-year-old investment bank Lehman Brothers and the nationalisation of Fannie Mae and Freddie Mac and AIG (America’s largest insurance company) within three weeks in September 2008, 25 26 Asia and the Subprime Crisis had raised concerns about the stability of China’s banking system.
It is equally unrealistic to expect Chinese consumption to pick up the American slack and help pull the world economy out the subprime crisis, because the scale of the adjustment is beyond the capacity of China to deliver. For example, a fall in US consumption amounting to 5% of GDP (which is a low estimate, given the scale of damage from the subprime crisis) would require a rise in Chinese consumption amounting to 17% of China’s GDP. To achieve this, Chinese consumption growth would have to reach 40% a year: a clear impossibility.
This type of adjustment will last for years because it takes a long time for the financial sector to rebuild capital. The fall in consumption in the developed world will put an end to the emerging markets’ export-led development model, which had supercharged their growth for over a decade, because external demand will be weak in the future. This also means that profit growth in the export-led economies and sectors will be constrained for years. Re-regulating the banks The subprime crisis is a man-made crisis, not a black swan event.