Did China create the crisis?

China's role in the credit crisis clearly makes for a fascinating case study. It still remains a relatively unexplored terrain even after the various postmortems of the financial meltdown.

In this book Giles Chance, a veteran China consultant and visiting Peking University professor, tries to unravel the credit crisis by focussing on the Chinese angle.

Chance deftly traces the genesis of the problem to China's induction into the WTO in 2001, and its subsequent integration into the global economy. It was an event of far reaching consequence and Chance makes the case that policy-makers across the globe failed to fathom its full import. So, did China cause the credit crisis? No, says Chance, but argues that without China, the credit crisis would not have happened—"China's emergence was an event big enough to change the way the world worked. The effect was hugely beneficial, but came with the risk of upsetting the world economy. Unfortunately, neither the effect, nor the risk, were really understood."

Chance does clearly establish the Chinese role in the credit crisis. In the process he goes beyond the predictable and obvious explanations for the meltdown. Sure, then Fed Reserve Chairman Alan Greenspan's policies and inadequate regulation of the financial markets were also responsible for the mess. But it was Chinese supply shock to the global economy, which created the conditions for the crisis.

A flood of cheap Chinese imports into Western economies, following China's induction into the WTO, put downward pressure on price levels from 2002 onwards. This price effect was important in persuading Western monetary authorities, particularly in the US, that price inflation had disappeared and that monetary stimulus, including lower interest rates, was necessary to stimulate growth and absorb unemployment.

Most experts perceived it as a deflationary demand trap, when in reality, it was an outcome of a big supply shock from China. Says Chance: "The monetary stimulus was unnecessary and helped create the disastrous real estate bubble at the heart of the crisis by making buying a house appear a much more attractive form of saving than a bank deposit, which carried virtually no return." As the author suggests, if financial policymakers had better understood the nature and effects of China's rapid ascendance, more responsible and appropriate policies could have been put in place to mitigate—and possibly avoid—the crisis.

China and the Credit Crisis examines the larger role that China will play in the recovery from the current credit crisis and in the postcrisis world. It tries to address the major questions which arise from the financial crisis and discusses the landscape of the post-credit crisis world. It highlights the challenge of providing a growth impetus to a world deep in recession, which will necessarily entail US and China sharing global economic and political leadership.

While Chance's book certainly makes an interesting read in the first four chapters, where the author fleshes out his argument on the China angle to the credit crisis, it loses the plot somewhat in subsequent chapters by turning its attention to China's growing clout in the global community and proximity with the US—much of this has already been well documented in the international media. Yet, the book makes an important contribution to our understanding of the recent turbulence in the global economy.