The Great Recession (or Global Financial Crisis, if you prefer this terminology) of 2007-2008 (in)famously had its origins in the United States. More specifically, everyone went crazy when it came to real estate in the US: the average consumer bought more than he could afford to by taking advantage of the easily available mortgage packages, bankers earned record-breaking bonuses by giving out loans to anyone with a pulse (including the so-called NINJA loans: No Income, No Jobs or Assets) and selling packages of them called Mortgage-Backed Securities to more or less sophisticated investors, insurance companies thought they were receiving free money by insuring against defaults their mathematicians considered unlikely to be systemically relevant and all parties involved were having a great time… until the party stopped.
As the Mortgage-Backed Security bubble popped and risked taking the financial system down with it, the effects spread well beyond the United States. Perhaps ironically, other nations ended up being more affected than the US due to the fact that for better or worse, “safe” US assets such as Treasuries were perceived as safe haven solutions, so scared investors actually panic sold a lot of their foreign assets and allocated that capital toward (some) United States assets instead.
With exports falling by 45%, China was hit… hard. While some might say that sure, China was of course affected in light of being a huge trading partner of the United States, it’s worth noting that nations such as Russia were also devastated despite not exactly being stellar examples of US business partners. Moving back to China, however, it managed to downright shock analysts with the fast recovery it was able to experience.
Mostly a combination between proverbially pumping money into the system but (unlike a lot of Western nations) firmly controlling how that money is spent. More specifically, a 4 trillion Yuan package was introduced back in 2008 (which amounted to almost $600 billion at that point in time) and invested in a centralized manner in anything from social programs to (massive) infrastructure spending.
Despite the Chinese GDP only representing 1/3 of the US GDP at that point, the stimulus package was similar in size to the United States one and the effects were felt much more quickly. Partly also a function of the fact that the Chinese stimulus package represented a higher percentage of China’s GDP than the US one but on the other hand, it’s important to understand that the Chinese authorities controlled what happened to that money more strictly compared to what Western nations can do.
Once again, ironically, something less than great generally-speaking actually worked in China’s favor in that particular scenario. More specifically, the fact that with SOEs (State-Owned Enterprises) representing a much greater share of China’s GDP than than the SOEs of Western nations (which, by comparison, seem negligible percentage-wise), China was able to control what happens to the money it proverbially pumps into the system on a more granular level. Comparatively, the let’s say Federal Reserve (the central bank of the United States) can indeed fire up the printing presses as well and did just that but what happens next is much harder to control. As such, with money ending up in places where it doesn’t produce economic growth such as simply being used as reserves by the banking system, the economic effects can take a lot longer to manifest themselves in Western countries.
For reasons such as the previously outlined ones, China’s measures “worked” better, with industrial production being double back in 2013 compared to 2007. However, “worked” is a tricky word to use in the world of economics because some measures which generate excellent short-term results may have unwanted longer-term consequences. As such, as effective as they have proven to be in extinguishing the Great Recession-generated fire, these measures essentially led to a government-induced allocation of capital in directions the market itself wouldn’t have chosen.
To put things differently, it led to overproduction across many sectors and if the economy is not able to gradually adjust, the risks can be systemically-challenging in nature. Furthermore, these measures are also partly to “blame” for the significant increase in China’s debt to GDP ratio. While we’re definitely not talking about a debt to GDP level that can challenge that of most Western nations when it comes to China, it’s worth keeping in mind that sometimes, countries can lose market access (access to capital) even with a (relatively) low debt to GDP ratio. As such, Argentina for example experienced a dramatic financial crisis despite having a debt to GDP ratio that was problematic but not huge, whereas let’s say Japan was doing just great despite having a humongous debt to GDP ratio by comparison. Just something worth keeping in mind.
After drawing the line, this much is certain: the Great Recession, despite having its origins thousands of miles away (the United States), was anything but kind to China in particular and emerging markets in general. Fortunately, China managed to recover remarkably well but this came at various costs, from sending the market mixed signals to increasing the nation’s debt to GDP level. As such, it’s imperative to keep our eyes on longer-term indicators to ensure our analysis is a balanced one.