Qi Jingmei

The demand for investment will continue to rise and fall. Over a certain period of time, the fixed-asset investment will maintain a growth faster than 20 percent and investment will remain the important force driving economic growth. In the first half of this year, China will continue to boost economic recovery with investment in large-scale infrastructure projects.

There are three reasons for this. First, the demand for infrastructure is robust. Second, 2013 is an important interim evaluation year for the 12th Five-Year Plan (2011-2015) and local governments will have new heads elected. Third, the loose financing environment will provide fund guarantees for investment in infrastructure construction projects.

Affected by the upgrading of the industrial structure, energy saving efforts and the macro-control polices issued by the State Council to curb rising house prices, the investment in manufacturing industries will drop slightly and investment growth in the real estate sector will slow down.

The primary driving force for the growth of consumption demand is constantly growing. Income is the most important factor deciding consumption growth. The fast growth of incomes will support a steady growth in consumption.

There are some factors driving consumption growth: First, the good incomes and employment situation of urban and suburban residents will support the steady growth of consumption. The employed population increased by 11.88 million in 2012 and resident’s real incomes in urban and rural areas grew by 9.6 percent and 10.7 percent respectively, higher than the GDP growth in China for the first time. It is expected that the central government will push forward comprehensive income distribution reform from many aspects, such as the primary distribution, redistribution, the growth of farmers’ incomes and distribution order. As this crucial reform is gradually carried out, China’s domestic consumption will gain more forward momentum.

The fast development of online consumption, community consumption and some other new consumption models will provide new powers driving China’s consumption. As China’s per capita GDP exceeded $6,000, China’s consumption structure entered an important period of upgrading and the consumption in cities is striding into the stage of “enjoying life” and rural consumption is entering the stage that features higher demand for living and traveling. The core drivers of consumption growth are the steadily growing demand for cars, medium and high-level household appliances and better services.

The gloomy prospects for exports, which are the result of the many global uncertainties and the slow recovery of the global economy, will be both favorable and adverse for the China’s foreign trade. The growth in China’s exports and imports in the first quarter of 2013 are expected to hit 8 percent and 6 percent.

The favorable factors include, first the strengthening signs that the global economic recovery is conducive to the steady operation of China’s export trade.  The Purchasing Managers’ Index, a global measure of manufacturing, rose from 49.6 percent to 50.2 percent in Dec 2012, passing the “vicissitude line”. The real estate market of the United States just saw its largest restorative growth since 2006 and the unemployment rate in the US declined to 7.8 percent. The deficits of some European counties are becoming smaller. And the economies in Greece and Spain are recovering slightly. The MIST countries (Mexico, Indonesia, South Korea and Turkey) and some small emerging economies’ growths are accelerating. The warming of the world economy will improve the foreign demands for China’s export in the first quarter. Second, the optimization of trade structures will continue. China’s export growth will be higher than the world’s average, China’s share in the world market enjoys great potential for expansion as China is trying to upgrade the production structure of its exports .

The adverse factors are as follows: First the pressure of exchange rate appreciation is big. The developed countries apply quantitative easing monetary policies forcing the yen and US dollar to depreciate fast. The renminbi’s appreciation against the yen lowered the real growth of China’s exports by about 2 percentage points. The US economy is recovering and its imports are rapidly growing and so its trade deficit is increasing. The US dollar will depreciate. The real effective exchange rate of the renminbi will appreciate, which will weaken the price competitiveness of China’s exported products and add pressure to the growth of China’s exports. Second, China will come across some obstacles on its way to joining the world multilateral trade system. After the financial crisis, all countries paid more attention to grabbing international market share. The US and European countries all made policies supporting exports and to contain the exports of China and the other emerging economies by introducing protectionist measures and building up trade alliances, which goes against the growth in demand for China’s exports.

Last but not least, the price level growth trend is for a mild rise. China’s domestic economy is warming up. The pressure of cost-pushed inflation is building up. The liquidity of the international currency market is becoming looser and the prices of staple commodities are recovering. Under such circumstances, the price of consumer goods will show a rising trend. The Consumer Price Index is expected to rise about 3 percent in the first quarter of this year, higher than the fourth quarter of last year, but lower than the same period of time last year.

Qi Jingmei is a researcher with the State Information Center.

He Weiwen

It is a persistent notion in the United States that the RMB is undervalued because China has been running a persistent, huge trade surplus, especially with the US. And thus, the RMB is particularly undervalued against the dollar. However, this supposed cause-and-effect linkage is actually not well proven.

First, the same exchange rate can see different trade balances. The best case for analysis is the Eurozone. During the first eight months of 2012, Eurozone countries had a wide disparity in their trade balances. Germany had by far the largest trade surplus of €125.3 billion, followed by the Netherlands, €31 billion, and Ireland, €29.3 billion. France, on the other hand, had a huge trade deficit of €56.5 billion. Spain and Greece also had trade deficits of €23.8 billion and €10.2 billion respectively. As all of these countries share the same currency – the euro – nobody would think their currency is undervalued. Nevertheless, the fundamentals behind these trade balances is the export competitiveness, not the exchange rate of each country.

Second, RMB exchange rate fluctuations during the past 12 years did not bring about relevant trade balance changes in either global trade at large, or trade with the US in particular. From 2000 to 2004, when RMB was pegged to the dollar at 8.28, China’s global trade surplus was actually small, ranging from $24-32 billion. Ironically, during the period of 2005 to 2008, when RMB floated and appreciated by 21.2% against the dollar, global trade surplus shot up by 825% to $295.46 billion, contrary to the general notion that appreciation leads to a fall in trade surplus. Then, global trade surplus steadily shrank to $155.14 billion in 2011, despite RMB being pegged to the dollar during the first year and a half and floated again during the last one and a half years. Throughout the period examined, China’s trade surplus to the US continued to rise, regardless if RMB was pegged to the dollar or not. Therefore, other factors leading to China’s trade surplus changes need to be explored.

Third, US exports to China have out-performed exports to the rest of the world. From 1997 to 2011, US exports to the world grew by 115.3% from $687.60 billion to $1,480.67 billion. However, US exports to China grew nearly three times as fast, increasing by 710.9% from $12.81 billion to $103.88 billion. Again, conventional notions don’t work. Had the RMB been undervalued, US exports to China should have grown more slowly. Nevertheless, during the same period, US exports to China grew 27% faster than imports from China, while US exports to the world grew 15% more slowly than imports, a fact that cannot be explained by an “undervalued RMB”.

Fourth, the same exchange rate also saw tremendous differences in different export categories from the US to China. According to US Department of Commerce data, US exports to China grew by 5.8% during the first 9 months of 2012. Exports of agricultural products grew by a remarkable 45.4% and transportation equipment grew by 17.3%. On the other hand, exports of computers and electronics barely saw positive growth at 1.1%. Furthermore, exports of chemicals decreased by 0.5% and exports of machinery faced a significant fall of 9.3%. However, all export groups face the same RMB exchange rate.

Finally, with the same RMB exchange rate, China has trade deficits with Japan, South Korea and Taiwan; yet it maintains surpluses with the EU and US. According to China Customs statistics, during the first 10 months of 2012, China had a $24.91 billion trade deficit with Japan, $62.86 billion with South Korea and  $77.87 billion with Taiwan. Despite having the same exchange rate, China has a $100.94 billion and $182.56 billion trade surplus with the EU and US respectively. Again the RMB exchange rate cannot explain the differences in trade.

Interestingly, over the past year, China’s trade deficit with Japan fell by 39% from a year ago, yet its deficit with South Korea decreased by a mere 3% and increased by 5% with Taiwan. Apparently, the exchange rate is not the reason for these changes as each country faced the same RMB. These large disparities can be explained by a big fall in China’s imports from Japan following Japan’s encroachment upon China’s Diaoyu Island. Big disparities were also seen in China’s trade positions with the EU and US, with a fall of 16.7% in its surplus with the EU and a rise of 10.3% with the US. It is obviously not explained by the one RMB rate, but by the fall of China’s exports to the EU following the euro debt crisis.

He Weiwen is Co-director of the China-US/EU Study Center at the China Association of International Trade

On April 16th, China has decided to loosen some of its currency controls permitting greater volatility in daily trade. Why is it flexible exchange rate necessary to achieve RMB globalization? The purpose of greater flexibility of exchange rate is to provide a mechanism for exchange rate to get closer to equilibrium, which is very important as a precondition for capital economic liberalization. In capital economic liberalization, without a flexible exchange rate, it is likely that by the time of opening the capital account, the exchange rate is still very different from equilibrium. If such situation happens, the opening of the capital account would be dangerous, because it might lead to a sudden increase of capital inflow or outflow. Therefore, the precondition of capital liberalization has to be more flexibility of exchange rate itself. This is one of the few steps towards more flexibility, and more increase in trading banks should appear in the coming years.

At present, China is ready to start capital account reform. The basic reform process will take three to four years. By around 2016, we will see basic opening of capital account. The basic opening is similar to a Taiwan model, which allows individuals to convert up to 5 million U.S. dollars, and a lot of companies to convert up to 50 million U.S. dollars.

Several steps reform China’s capital account towards opening up. The first step is to increase the quarter of individual currency conversion. For example, China can raise personal conversion rate to 200,000 U.S. dollars per person per year and raise corporates conversion rate to 2,000,000 U.S. dollars. This is something China can do right now without worrying about a major change in net flow, because the expectation of exchange rate is quiet stable right now. As China opening up its capital account step-by-step, individual and corporate conversion limit would still exist but go up. It is known that informal conversion is happening anyway, yet China still need to formalize this process and to make the process more transparent. The second step is to allow local capital markets be more open to foreign institution investors, for example, raising the quarter for foreign institution investors to enter Chinese inter-bank market. The third step is to allow foreign institutions to issue RMB bonds in Chinese bond market, and set up the international board of the Shanghai equity market for international insurance and also allowing foreign corporate to borrow from Chinese banking system. These actions will form the core of basic opening up of the capital accounts.

RMB globalization is allowing RMB to flow between China and the offshore market more freely for capital account purposes. So far the RMB flow for trade accounts is already open. What to do next is first to open the capital account transaction in RMB, and second to open the capital account, allowing conversion between RMB and hot currencies more freely. These two reforms are equivalent in nature. As in some aspects, when allowing investors to bring more U.S. dollars into the Asian bond market, it is equivalent to allowing foreign institutions from bringing CNY from Hong Kong market to the local market. Because from the investors’ perspective, they will convert U.S. dollars or other hot currency into CNY and RMB anyway. Therefore, the impact on the investors is the same. Also, the impact on monetary policy will be the same as well.

The biggest influence on China’s inbound and outbound direct investment should be on portfolio investments. Lifting the restrictions on investments on the Chinese local equity market and relaxing the quarter on international bank investment market will bring more foreign capital flow into Chinese domestic bound and equity markets. At the same time, ODI will be promoted by an easier approved process and less restrictions on the foreign currency conversion. It is most possible that, in the coming few years, we will see two-way flows getting stronger. One is portfolio inflow. The other is ODI outflow. On balance, we may not see a big change on the net flow in the next three to five years.

To conclude, in the next five to ten years, the impact of capital account open up would have a small impact on foreign currency reserve, and foreign currency reserve would going to be rather steady going forward.

Ma Jun is Chief Economist of Deutsche Bank.

Nonetheless, the Dialogue was surprisingly productive, in light of the magnitude of challenges facing the global economy and Sino-U.S. bilateral relations today. 

Most importantly, it precipitated a major shift in China from economic reforms toward financial reforms.

Centrifugal pressures in commodities

Another result of the S&ED was a deal that will let foreign groups establish joint venture brokerages for Chinese commodity futures.

China is already one of the world’s largest importers of iron ore and copper, and a force in the gold market. Nonetheless, the current status quo is unsustainable. On the one hand, China is the world’s largest consumer of commodities. On the other hand, China is largely on sidelines with regard to global commodity prices, which continue to be set in London, New York City, and Chicago.

In the future, this is likely to change as the renminbi (RMB) is expected to become a key commodities currency. Some analysts expect that to happen in “just 10-20 years.” But change could occur faster.

Due to its continued urbanization drive, coupled with high global demand for commodities, and rising inflation, China cannot stand on the sidelines when it comes to having a say in setting commodity prices.

True, the continued reliance on Western markets to set prices is based on trust in established legal systems and the security of pricing contracts in a freely convertible currency. But even the U.S. dollar cannot rule indefinitely markets driven by China and other large emerging economies.

Accelerated RMB internationalization

A few years ago, a number of nations – reportedly, China, Russia, Brazil, Japan and oil producers in the Middle East – agreed that oil should no longer be priced on U.S. dollar by 2018. It is only prudent to assume that significant pricing changes in one commodity are likely to parallel those in other kinds of commodities.

China may be moving faster to foster capital account convertibility, declaring that the RMB can be used more internationally while the latter remains partly inconvertible. Concurrently, Chinese regulators may reserve the right to reduce liberalization at times of turmoil. After the Asian financial crisis in 1997-1998 and the global crisis of 2008-2009, there is more understanding toward such policies worldwide.

In turn, higher foreign earnings from international capital market and asset management activities will further increase the power, profitability and status of Chinese banks. These banks are also expected to move into asset management, trade finance and project finance, which Western banks used to see as their exclusive playing field.

Recently, the first Hong Kong – London forum promoting the offshore RMB business pledged to cooperate in boosting the offshore business. The alignment of these two global financial hubs provides China a financial center in Europe, which will contribute to the RMB internationalization.

In London, a number of initiatives were announced or signaled. One plan is to “provide direct foreign exchange quotes of RMB against GBP, Euro, and other currencies.”

Years of currency friction between Washington and Beijing and the ongoing harsh election rhetoric in the United States may contribute to such plans. China is enhancing the international position of the RMB, while reducing China’s dependence on the U.S. dollar.

Year of privatizations?

In the past few months, the more-or-less-informed observers in the West have been betting that China is about to suffer a “hard landing.” And certainly, China is not immune to the recessionary conditions that have swept the West.

However, it may be useful to recall that when the world economy was amidst its free fall in fall 2008, same observers were confident that China faced imminent collapse, plummeting growth, divisive riots and social chaos.

China is at a new crossroads, but the sense of gloom and doom may miss the big picture. In February, China’s State Council defined the execution of a new round of privatizations as the paramount priority among all planned reforms in the ongoing year. The “New 36 Clauses” is a prudent but practical plan to push privatization in state-owned assets in monopoly sectors, including railways, energy, financial, telecoms, education and healthcare.

While the skeptics like to point out that these plans are hardly new, times are changing.

Today the world is curved, lumpy and unpredictable. The Eurozone crisis has barely begun. In the U.S. the economic hangover will hit home after the elections. And money presses will continue to be overheating across the West.

When the world economy was still amidst rapid global growth, local governments and state-owned enterprises (SOEs) had few incentives to privatize.

Today, complacency is no longer an option.

The Great Transition

Despite three decades of success in economic reforms and a decade of rapid achievements in financial reforms, China’s financial system has a long way to go.

True, China’s banking, brokerage, insurance, and asset management industries have enjoyed robust growth and sound profits for more than half a decade. In the process, equity, bond, and currency markets have expanded substantially.

Today, the 75% ceiling for loan-deposit ratio (LDR) continues to constrain commercial banks from growing their lending.

China’s nascent and fragmented bond market remains too small to fulfill the needs of corporate financing.

Commercial banks are coping with increasing capital adequacy pressure and must raise capital frequently. Securitization of loan portfolios could be one way to alleviate such pressures.

China’s financial markets remain relatively closed to most foreign investors and financial institutions. The gradual lowering of entry barriers could support a secure and gradual internationalization of Chinese financial markets, while boosting competition in the system.

In 2012, much of the financial reforms will occur vis-a-vis pilot programs, which herald acceleration in the equity markets in the coming years.

Recently, China's stock exchanges in Shanghai and Shenzhen also moved to allow small firms to sell bonds via private placement, opening another fundraising avenue for the country's cash-strapped small-business sector.

Moreover, China's brokerages will be allowed to take on twice as much debt in relation to their net assets, and will be given easier access to the capital markets. 

As China is stepping up market and financial reforms, it hopes to make Shanghai a key global financial hub by the end of the decade.

Further financial deregulation, gradually

Instead of a rebound, the economic slowdown in China accelerated in April. The policy loosening measures introduced after October 2011 have not yet contained the downtrend. As a result, more policy support is needed to prevent a sharper downturn in the coming months.

As the inflation pressure continues to recede, China can initiate more forceful loosening measures. New reserve requirement ratio cuts are to be expected, along with other similar measures.

The government is also more likely to soften the tightening policies on infrastructure and property investment to prevent a sharper decline in investment growth. 

It would be naive to expect the impending policy shift to translate into a profit bonanza for American banks. Along with real estate, U.S. financial sector played a central role in the global financial crisis in 2008-2009. These highly concentrated, gigantic banks remain “too-big-to-fail.”

Similarly, giant banks in Europe are highly exposed to high-risk regional debt.

It was the gradual approach that made Chinese economic reforms a success. It is that rare combination of ambition and caution that is now needed even more in financial reforms.

China is moving toward financial reforms, decisively – and gradually.

Dan Steinbock is Research Director of International Business at the India, China and America Institute.

The lack of common ground among the BRICS has prompted cynics to call the grouping an acronym with no substance. To its protagonists, however, it is a product of today’s ongoing global power shifts, and has the potential to evolve into a major instrument in shaping the architecture of global governance – the midwife of a new international order.

After all, the BRICS economies are likely to be the most important source of future global growth. They represent more than a quarter of the Earth’s landmass, over 41% of its population, almost 25% of world GDP, and nearly half of all foreign-exchange and gold reserves. The BRICS, in fact, might also be dubbed the R-5, after its members’ currencies – the real, ruble, rupee, renminbi, and rand.

At the New Delhi summit, the BRICS leaders will discuss the creation of joint institutions, particularly a common development bank that can help to mobilize savings between the countries. Currently, the BRICS countries constitute a loose, informal bloc. If the group’s leaders fail to make progress on establishing an institutional structure, they will lend credence to the contention that it is merely a “talking shop” for countries so diverse that their shared interests, to the extent that there are any, cannot be translated into a common plan of action.

It was just last year that BRIC (Brazil, Russia, India, and China) became BRICS with the addition of South Africa. The BRIC concept, conceived in 2001 by Jim O’Neill of Goldman Sachs, was embraced by the four original countries only in 2008, when their foreign ministers met on the sidelines of a Russia-India-China (RIC) trilateral meeting. The addition of Brazil paved the way for the first BRIC summit in 2009, which, interestingly, piggybacked on the Shanghai Cooperation Organization (SCO) meeting in Yekaterinburg, Russia, that year.

That association helped the SCO – still largely a Sino-Russian enterprise – to receive more publicity, but it left the BRIC countries with little space to start formulating a unified action plan. The subsequent enlargement to include South Africa has made the BRICS a more global grouping, which threatens to render irrelevant yet another initiative, the IBSA (India, Brazil, and South Africa).

For Brazil, Russia, India, and South Africa, the BRICS grouping serves as a forum to underscore their rising economic clout and showcase their emergence as global players. But, for China, which needs no recognition as a rising world power, the BRICS offers tangible – not just symbolic – benefits. As a result, China indeed has cast a lengthening shadow over the group, openly seeking, for example, to control the proposed common development bank – something that India and Russia, in particular, are loath to accept.

At a time when China is under pressure for manipulating the value of the renminbi to maintain export competitiveness, the BRICS framework offers it a platform to expand its currency’s international role. As part of its quest for a global currency that could rival the dollar or the euro, a cash-rich China plans to extend renminbi loans to the other BRICS members.

Lending and trading in renminbi is likely to boost China’s international standing and clout further. But its undervalued currency and hidden export subsidies have been systematically undermining manufacturing in other BRICS countries, especially India and Brazil.

Proponents of the BRICS concept nonetheless remain hopeful that the group can serve as a catalyst for global institutional reform. With existing international arrangements remaining virtually static since the mid-twentieth century (even as non-Western economic powers and nontraditional challenges have emerged), the world needs more than the halfhearted and desultory steps taken thus far. The formation of the G-20, for example, was an improvisation designed to defer genuine financial reform.

In fact, the modest measures implemented in response to the changing distribution of global power have been limited to the economic realm, with the hard core of international relations – peace and security – remaining the exclusive preserve of a handful of countries.

China is not on the same page as the other BRICS countries when it comes to global institutional reform. It is a revisionist power concerning the global financial architecture, seeking an overhaul of the Bretton Woods system. But it is a status quo power with respect to the United Nations system, and steadfastly opposes enlargement of the Security Council’s permanent membership. It wishes to remain Asia’s sole country with a permanent seat – a stance that places it at odds with India.

If the BRICS countries are to jell as a pressure group in international relations, they must agree on what they believe to be attainable political and economic objectives. For example, they are generally united in their frustration with – but not in their proposed response to – the dollar’s status as the world’s reserve currency. Indeed, the most important bilateral relationship each BRICS country has is with the United States.

The BRICS concept represents, above all, its members’ desire to make the global order more plural. But it is uncertain whether the group’s members will ever evolve into a coherent grouping with defined goals and institutional mechanisms. In the coming days, we might find out whether the BRICS will ever be more than a catchy acronym with an annual boondoggle attached.

Brahma Chellaney is a Professor of Strategic Studies at the New Delhi-based Center for Policy Research and the author of Asian Juggernaut and Water: Asia’s New Battleground

Such swap agreements allow the two signatory nations to do business with each other using their own currency and skip having to buy dollars and settle the trade invoices in dollars.

Ostensibly such swap agreements facilitate bilateral trade by making it more convenient to do business for both parties. Some of China’s first agreements, such as with South Korea, Argentina and Brazil, appeared to be for this purpose. But, there are other benefits to swap agreements.

Swap agreement with a weaker economy gives the smaller country a lifeline into global trade with dollars they don’t have or not having to spend what few dollars their central bank do have.

Up to now, China has entered such swap agreements with18 countries and counting. The latest was signed with Turkey on the occasion of Vice President Xi Jinping’s stopover on his world tour after the U.S.

For such countries as Iceland and Belarus, they get to swap their struggling kronas and roubles for the strong and stable yuan, the basic unit of China’s Renminbi (RMB).

By adjusting the exchange rate between the two currencies along with financing, the swap agreement can also serve as a kind of trade subsidy and foreign aid as apparently is the case with Pakistan.

Currency swap deal can also serve as a tool for diplomacy as China’s premier, Wen Jiabao, demonstrated in his recent visit to the United Arab Emirates. A highly publicized 35 billion yuan swap agreement was signed amidst much fanfare and an implied step forward to getting oil from the Persian Gulf.

By far the most noteworthy swap deal to date was announced on the occasion of Japan’s Prime Minister Noda’s visit to Beijing in late December. The significance and size of this deal far surpass all the others.

This is a deal between the second and third largest economies of the world.  China is already Japan’s largest trading partner. Their bilateral annual trade exceeds $340 billion, nearly tripling in a decade. Their swap agreement means being able to opt out of using billions of dollars in their transactions.

Furthermore, as part of the agreement, Japan will be allowed to buy yuan denominated bonds issued inside China. In effect, Japan has been invited to participate in the growth of China’s future economy as well as in the much-anticipated appreciation of the RMB.

This is a classic example of where shared economic interests can trump even animosity stemming from bitter memories of WWII Japanese atrocities and continued tension over the possession of uninhabited islets in East China Seas.

Bilateral swap agreements also suits Beijing’s preference for instituting changes in small steps, by allowing Beijing to gradually loosen the control of its RMB outside of China in measurable and predictable increments.

Countries that have such swap deals with China will in effect diversify from their dependence on the dollar as their only hard currency reserve by holding on to the Chinese yuan as a de facto reserve currency. Not only can they use the yuan in their trade with China but presumably also with other countries that have swap agreements in place with China.

Thus by proliferating bilateral swap agreements, China will in effect be creeping up on having RMB become a reserve currency and an alternative to the dollar.

How shall the United States react to this ongoing development? First of all, let’s concede that there is not much the U.S. can do about it. Everybody knows that the long-term value of the dollar is on a declining trajectory. That is a direct consequence of the US ongoing fiscal policy and nothing is on the horizon that will reverse the trend. It’s natural for other countries to diversify and not want to hold too many dollars.

However, we believe the US has the option to react positively or negatively. The positive side is simple. Coexistence of the yuan alongside the dollar takes the pressure off the dollar as the only viable reserve currency. This should enhance a more stable worldwide economy and one less thing for the Fed to worry about.

For a myriad of reasons, there is no likelihood that the yuan will replace the dollar as the reserve currency, at least for the foreseeable future. It would be in Washington’s interest to work with Beijing and coordinate their economic policies.

A negative response is for Washington to continue to confront and bicker with China. In November, President Obama announced the Trans-Pacific Partnership as ostensibly an antidote to China’s expanding economic influence. It remains to be seen whether TPP will have any real impact that will benefit the member nations.

On the other hand, China along with Japan and South Korea are already members of ASEAN+3 multi-lateral agreement on a $120 billion regional currency swap fund. The fund was set up to bail out member nations in times of illiquidity or balance of payment shortfall, possibly rippling from the European financial crisis. The members are considering doubling the fund in response to the perceived increasing threat of global instability. That’s a tangible safety net compared to the feel good promises of the TPP.

Unfortunately the coming presidential campaign along with the vociferous members of Congress is unlikely to ease up on their bellicose rhetoric directed to China. They really should take a page from the British.

After the China-Japan swap agreement was announced, British Chancellor of the Exchequer, George Osborne, rushed to Hong Kong in January. The government official of the former colonial ruler was in its former colony to pitch London as Hong Kong’s European satellite and get a piece of the growing RMB exchange business.

It is after all better to make money together than sending hot air missiles at each other. If China and Japan can overlook their deeply rooted differences for mutual benefit, why can’t the US and China, where the differences don’t go much beyond the rhetorical?
 

George Koo is a retired international business advisor and board member of New America Media and Henry Tang is retired investment banker and founding chairman of Asian Financial Society

The bilateral trade has developed extremely fast since China and the United States formally established diplomatic relations. According to the official statistics of America, the U.S.-China trade has grown from $2.37 billion in 1979 to $456.8 billion in 2010, a 193-fold increase. A growth of this kind is unimaginable without the presence of mutual benefit.

The U.S.-China trade reached $456.8 billion in 2010 accounting for 14.3% of the U.S. foreign trade, $3190.2 billion in total. The U.S. imports from China (including HK transit) in the same year reached $364.9 billion, accounting for 19.1% of the U.S. total imports, $1912.1 billion. The U.S. exports to mainland China and HK reached $118.5 billion, accounting for 9.3% of the U.S. total exports of $1278.1 billion. China and the United States have become crucial “strategic trade partners” with mutual benefit and interdependence.
 
As China and U.S. are respectively situating in two different stages of modernization process, they are strongly complementary in terms of industrial structures. Their complementarities of comparative advantages in the bilateral economic and trade cooperation are the largest and broadest international division of labor and cooperation in the world today. The United States set out the third industrial adjustment in the early 1980s that led to a mass shift of labor-intensive industries to abroad. It coincided with the onset of reform and opening-up policy in China that absorbed foreign capitals and developed a processing trade both in a massive scale.

To take shoe-making industry as an example, in 1976, 53 of every 100 pairs of shoes on the U.S. shoe market were made by American enterprises, while it fell to 22 in 1986, 11 in 1996, and only one and a half in 2006. Now 98% of shoes worn by Americans are of imports, of which some 80% are made in China. The most of the Chinese exports to America are inexpensive daily consumer products though good in quality. This meets the demand of American market, alleviates inflation in America, and provides American adjustment of industrial structure and economic development with necessary supplement.

According to the survey of Morgan Stanley, China’s trade surplus with U.S. were $229.2 billion between 1996 and 2003. Those good though inexpensive goods have saved over $600 billion for American consumers, lowered cost for American producers and helped America control inflation.

International trade is based on complementarities of comparative advantages. A Chinese worker earns 1.5 dollars per hour, while it is 18-20 dollars for an American worker. The labor-intensive product like shoes will be stunningly high in price if they are made by American workers. American advantage lies in high technology. China has purchased over 600 jumbo jets from Boeing since 1980. A hundred million dollars worth of every 747 jumbo jet provided America with many new jobs. On the part of China, it will sell 50 million pairs of shoes in exchange for just one jumbo jet. China is not only the largest exporter to the United States, but also the fastest growing market for U.S. export. China was the 11th largest export market for America in 2000 and took over Japan as the third largest in 2007. According to the United States-China Business Council, the U.S. export to China had increased 465% from 2000 to 2010; its export to other partners except China increased only 56% on average; of which the export to Japan had dropped 7.4%. In October 2010, the U.S. Department of Commerce designed a blueprint to double export to the top 10 export partners between 2010 and 2014, to increase export to Canada by 2.4% per year, to Mexico by 3.7%, to Japan only by 0.4%, while to China by 16.7% (actually, U.S. export to China had increased by 32% in 2010). With this view, Obama’s five year plan to double export will hardly succeed without the big market of China. American scholars had better to calculate carefully how many jobs can the fast growth of U.S. export to China create for America and they should take a look of whether China-U.S. trade can do more harm than good or do the other way around to America?!

Furthermore, as the bilateral trade fast increases, so expands the U.S. investment in China. From 1980 to the end of June 2011, the U.S. actual investment in China had reached $66.9 billion, with over 60,000 enterprises setting up. According to the 2011 Business Climate Survey Report conducted by the American Chamber of Commerce in the People’s Republic of China (AmCham-China) in March 2011,  85 percent of American companies in China reported an increase in revenue in 2010. It must be pointed out that 40% of Chinese exports to America are produced in China by American companies. In other words, the revenues of the exports to America produced by American enterprises in China are counted as Chinese trade surplus with America, while the money are remitted to America by American enterprises. In this case, the U.S. Congress and government are untenable to push for RMB appreciation in excuse of American trade deficit with China.

The financial crisis erupted in America in 2008 had evoked the worst post-war American recession with a sluggish as well as painful recovery, and led to a high unemployment rate and poverty rate. But that has nothing to do with China-U.S. trade. The former U.S. Ambassador to China Stapleton Roy had told this author that this crisis had made Americans clear that the U.S. economic difficulty is caused by financial crisis and had nothing to do with RMB exchange rate.

When it comes to the question how large the harm the American financial crisis has inflicted on China, few scholars seem to have researched seriously.

Zhou Shijian is senior researcher at the Center of American Studies, Tsinghua University

Almost all discussions about renminbi internationalization have focused on the following issue so far: Should China step up the pace of liberalization of its capital account during the current international financial tsunami? If yes, what would be the right sequence and timing? This is a question we must answer before we take up the topic about promotion of renminbi internationalization.

The issue of renminbi internationalization has come to gain spotlight at a time when Chinese enterprises have come to be exposed to ever greater exchange risks and China’s foreign exchange reserves have come under ever greater pressure of capital losses. In practice, however, renminbi internationalization has been dissimilated into a lever to pry up the fire wall monitoring the cross-border flow of Chinese capital. 

The progress of renminbi internationalization in the past year was best seen from the rise of renminbi deposits and the expansion of renminbi bonds issuance in Hong Kong, with thanks going mainly to the Chinese government for lifting its control over the swap and use of foreign exchanges for trade settlement by allowing importers to buy foreign exchanges with renminbi in Hong Kong for trade settlement and exporters to settle trade with renminbi.   

At a time when the exchange rate of the Chinese yuan is lower on the Chinese mainland than that in Hong Kong (where the Chinese yuan is comparatively more expensive and the US dollar is comparatively cheaper) and when the interest rate at the mainland money market is noticeably higher than that in Hong Kong, permission of the flow of runoff renminbi back into the mainland money market, which would mean permission to non-residents using the renminbi in their pockets to invest in financial assets (renminbi bonds or renminbi FDI being planned for the future) on the mainland, those holding renminbi will reap double incomes through exchange and interest arbitrage. This explains the sharp rise of renminbi deposits and the fever for renminbi bonds in Hong Kong. 

Capital account liberalization is of positive significance, and may also become inevitable in the end. It may also possibly trigger, however, a sudden flow of international capital into or out of a country, thus violently shaking the economic stability of this country. Under normal conditions, cross-border capital flow changes with interest or exchange arbitrages or other kinds of profiteering activities, and as such leaves due impacts on the economic and financial stability of a country. For economies that have completed market-oriented reform of their interest and exchange rates before liberalization of their capital accounts, the hazards from cross-border capital flow to their macro economic stability can be minimized. Nevertheless, these economies still need to resume capital control under some extraordinary circumstances, so that the opportunities for interest and exchange arbitrage will be scrapped within a short period of time along with changed interest and exchange rates.

So far as China’s present-day situation is concerned, neither the interest nor the exchange rate is quick enough to react to market signals. Under such circumstances, liberalization of the capital account will only give investors opportunities for interest or exchange arbitrage. With little or no risks at all, such arbitrage will never come to a stop, only to plunge the state (and taxpayers) into welfare losses in the end.

The renminbi internationalization as China has been promoting is actually an experiment with liberalization of the capital account before completion of its market-oriented reform of interest and exchange rates. Liberalization of the capital account is a prerequisite for internationalization of a currency, but not an ample condition. During the course or after completion of capital account liberalization, many other conditions including political ones must also be met before final achievement of currency internationalization. 

he progress China has chalked up so far in renminbi internationalization is mainly – but not totally – a byproduct of its measures to liberalize a special part of its capital account under some special circumstances. To be more specific, China has achieved its up-to-date progress in renminbi internationalization mainly because international investors, seeing that the US dollar will continue to depreciate and the US bonds will surely be downgraded in the long run due to continuous deterioration of the US financial situation and that the eurozone debt crisis has kept worsening, are inclined to readjust the currency mix of their assets and liabilities by increasing their hold of the Chinese yuan while cutting that of the US dollar. The policy measures taken by China to internationalize its currency have precisely satisfied this demand from international investors. The progress in renminbi internationalization achieved in such a manner may easily come to a standstill or even go down the drain, however, with changes in the flow of international capital. 

In the third quarter of 2011, the sum of cross-border trade settlement in renminbi fell below that in the second quarter, and the dimsum bonds were sold off in large quantities. This setback in the course of renminbi internationalization has proved one fact, namely, renminbi internationalization based exclusively on renminbi appreciation expectations will never hold for long. More importantly, it is now high time to reexamine the course of renminbi internationalization that has run for more than a year.

With this understanding, our discussion of efforts to further renminbi internationalization should go back to the issue about how to reshape China’s mechanism for the formation of interest and exchange rates. Instead of centering our current discussions on the roadmap to advance renminbi internationalization, which is actually a timetable for pushing forward capital account liberalization, we should rather direct our efforts first to drawing up a timetable for liberalizing our interest rates and transforming our mechanism for exchange rate formation.

Thanks to the advancement of renminbi internationalization, some foreign investment banks and Chinese conglomerates saw their purses burst last year. For their own ends, these people will surely urge the Chinese government to further lift its control of capital and get renminbi internationalization into a momentum as strong as before, such as raising or even removing the ceiling of renminbi used for trade settlement. These will be suggestions that can never be adopted. On the contrary, we should suspend promulgation of new policies on renminbi internationalization. Or to be more accurate, we should suspend measures on capital account liberalization before any decisive progress is reaped in our interest and exchange rates reform. 

When we suggest not doing something, we do not mean not to do anything at all. The recent change in expectations for the renminbi exchange rate due to the outflow of international capital is actually a good thing. The monetary authority may shake off some pressure, for instance, from the yuan appreciation. It will not feel so pressed, in other words, for foreign exchange reserve growth or hedging operations. The latest reserve ratio cut, for instance, may have something to do with the shrink of liquidity due to declining foreign exchange reserves. The current two-way fluctuation of the renminbi exchange rate should be treasured as a rare opportunity for stepping up reform of its formation mechanism.

We have got two options.

First, taking advantage of the current opportunity from the balancing foreign exchange market to establish a whole package of clear-cut rules governing exchange rate fluctuations, rules that comply with the targets set for the exchange rate reform. Specifically speaking, three intermediate parameters should be written into these rules, namely, the proportion of current account surplus to GDP which shows the target for external balance, the amount of renminbi outstanding for foreign exchanges which marks the target for internal balance, and the effective exchange rate which tells our competitiveness in export and costs in import. During the course of managed fluctuation of the renminbi exchange rate, these three intermediate parameters may be turned, through weighting, into a comprehensive parameter to provide the basis for working out a whole set of clear-cut rules on government control of the foreign exchange market.

Second, announcement by the central government, at an opportune time, to stop its interference in the foreign exchange market and leave the exchange rate to market decision, an option that is a little bit more radical but also much simpler. Achievement of free fluctuation of the renminbi exchange rate will root up the thorn pricking Sino-US relations for good.

Under the current situation, big-margin appreciation of the renminbi is hardly likely even if the Chinese central bank ends its interference in the exchange market. On the contrary, its depreciation might be possible. Even the latter happens to be case, the US would say nothing more (because China has not manipulated its currency). Given the fundamentals of the Chinese economy, appreciation will be the long-term trend of movement of the Chinese yuan. Viewed from China’s position in international balance of payments, the yuan’s appreciation will only move within a limit affordable by the Chinese economy. Should any mishaps crop up, the capital account might be their soil. 

One possibility may be the sudden inflow of hot money at an unexpected speed. Should this happen, the yuan may over-appreciate. As a precaution, China should take good care of its capital account to dam the inflow of hot money. By non-interference, we do not mean total freedom for renminbi fluctuation. We will try to curb the inflow of foreign capital through exercise of capital account control so as to prevent the yuan’s over-appreciation. The central bank may also preplan for unexpected developments so that it can step in once again to interfere, just as in Japan’s case. But will the US reach out for a yard after taking an inch? It will, fore sure. In such a case, it will be fairly easy for China to counterattack and win greater international support.

In one word, the topic about renminbi internationalization may be put aside for the time being. In face of the upheaval of the international financial market, China should tighten instead of loosening its capital control to keep off external impacts, just as most developing countries have. Under the protective wing of capital control, efforts may be made to quicken the pace of market-oriented development of the interest and exchange rates. Issues about capital account liberalization and renminbi internationalization will be brought up only when due conditions have ripened.

Yu Yongding is an academician of the Chinese Academy of Social Sciences