How will the financial crisis evolve? This author believes there are six major developments worth noting.

Firstly, the current financial storm may be over within two to five months (the financial storm is defined as the superposition of two events, i.e., bankruptcies of large-scale financial institutions and the drying up of the short-term lending market). The reason behind the forecasted end is that authorities worldwide now are attaching great importance to the crisis and sparing no efforts to fight against it in a more coordinated fashion, which differs considerably from a month ago.

Secondly, the financial storm will evolve to a third stage in which a large number of emerging markets will fall victim. Ukraine, Pakistan, and Hungary have already been hit by financial problems and received assistance from the IMF (International Monetary Fund). The crises are hitting these nations harder, as they do not have the power to issue international currency. As a result, the financial crisis immediately gave rise to the balance of payments crisis. The situation for China’s neighbors, such as Korea and India, is also precarious.

Thirdly, even if the storm ends in five months, it will take a heavy toll on the real economy of developed countries. Nevertheless, the damage would be relatively short-lived and shallow, lasting three to four quarters at most. But it would lead to a shrinking consumer market in the west, the US in particular, as their consumer credit mechanisms take a hit. With a contracted consumer market, western economies will see a relatively long period of low increase, up to five to ten years.

Fourthly, the United States and Europe will be the biggest winners. The UK and US are currently borrowing money from the international market and using it to buy financial stocks that have slumped by 40% to 50%. It is worth noting that the US dollar hasn’t dropped in value but rather risen substantially amid the financial storm. Prices in the US Treasury have also seen big rallies. Therefore, authorities in the United States and Europe are likely to make huge gains in three years. But other sovereign authorities with huge holdings of US dollar foreign exchange reserves, including China, might lose with inappropriate handling amid the massive financial bailouts. In this context, China should treat with caution.

Fifthly, the US dollar will inevitably enter a slump. In the long term, support from the US dollar comes from the real economy as well as the health and size of their financial markets. It is difficult for US real economy to restore high-speed growth over the medium and long term. According to historical experience, in the aftermath of a financial crisis, the United States and Europe are likely to enter a period characterized by over-regulation of financial markets. Therefore, it would be difficult for their financial industry to be on its feet again. Meanwhile, to bailout financial institutions, the US has issued nearly US$1 trillion of government bonds. If the US economy continues to be sluggish and doesn’t become attractive to financial markets, the country’s financial products will be similarly unpopular. This implies that the demand for the dollar is likely to decline.

Sixthly, a new international financial order is unlikely to be built any time soon. Today’s situation differs radically from 1944, when the United States was the biggest winner of World War II. The US had huge economic and military strength while its international trade flows accounted for a much lower proportion of its GDP. International capital liquidity was also much lower than today. This situation facilitated an international consensus over the global hegemony of the US dollar.

Today, there is no single economy or combined economic entity (such as the European Union) that can generate a corresponding hedge against cross-border financial flows. It is impossible to produce a completely fixed new exchange rate system, nor for a couple of economies to establish a new system by signing an agreement. Therefore, non-cooperative gaming will be a major basis for international finance in the future. The new international financial structure will thus develop more out of fighting rather than negotiating.

During the process, three of China’s fundamental interests are involved. Firstly, China will soon have the largest savings and become the largest foreign investor in the world. China’s financial system has not yet been fully deregulated and its financial reform must move forward. However, China hopes to adjust on the basis of stability in order to stabilize of international financial order and avoid a similar financial turmoil. Besides, China does not expect any significant fluctuations in exchange rates.

China also hopes to achieve the globalization of the Chinese Renminbi by adopting a gradual and controllable approach. When the RMB goes global, the nation will be able to avoid the balance of payments crisis, not to mention some desirable income from international coinage. Under the financial crisis, why hasn’t the US caused the balance of payments problem nor anyone speculated on the US dollar? Because the dollar is the dominant international currency, and the Federal government has the power to issue and print international bank notes. Achieving a globalized RMB is China’s long-term goal.

Thirdly, China should participate in building an international financial order to demonstrate its image as a responsible power and enhance its international leadership. Over the short term, China may not have such ability; however, China should participate by cooperating with governments from a number of different countries.

In the process, China may take initiative on three fronts: (1) support and participate in reinforcing international supervision and monitoring over financial institutions and financial markets; 2) call for better co-ordination of rescue packages among different countries; and (3) call for reforms under the framework of the IMF, including the increase voting right and capital injection right of developing countries. Another area of focus include taking the Chinese RMB and other currencies as basis when encouraging the IMF’s voting rights. Concerning IMF rescue mechanisms, the introduction of a national bankruptcy mechanism is expected. China should also call for co-ordination among all major currencies to maintain stable exchange rates.

All in all, the current financial turmoil and the ensuing debates on a new international financial order present both challenges and opportunities. As a rising power, China should be and will certainly seize the opportunity, not only to show its leadership and the image of a responsible great power, but also to lay a solid foundation for the next 30 years.