China to play a meaningful role in rebalancing HAIHONG GAO Institute of World Economics and Politics, CASS “Recovery toward what? Finance, justice, sustainability” 6 November 2009, London CASS-IWEP

Where China stands in the global imbalance What options China has-- Foreign reserve allocation? Chinese exchange rate policy? Further financial liberalization and opening? Chinese idea of “super-sovereign reserve currency”? Chinese regional economic policy? RMB internationalization? CASS-IWEP

China on one side of the equation Sino-US imbalance came to the center Some discussions of trade imbalance take one side and blame the another: China is the origin of all the problems; Some others blame that it is the US’s fault for the trouble. China and the US are on two different sides of one equation: Any blame on one side is only half of the story; It is a collective failure of all the participants. One critical point: What brought China and the US together in the beginning? China lacked foreign reserves; The US has dollar printing machine. => The mutual benefit when China’s mercantilist policy met the US debt economy. CASS-IWEP

The real trouble China’s twin surpluses and reserve accumulation Failure of utilizing domestic savings for domestic investment CASS-IWEP

China has become the world biggest creditor Net capital exporters 2008 world capital importers CASS-IWEP

1. Foreign reserve allocation? What are Chinese options to play a meaningful role? 1. Foreign reserve allocation? CASS-IWEP

How China allocates its 2.27 trillion FXs? MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES ( $ billion) Top10: 80%; China 23% Dilemma facing the holders: Dollar is going to be weak, but getting rid of it will make it weaker and faster. One only way out is to have more substitutes, but where do they come from It’s worrisome for China: Put all eggs in one basket: Foreign reserves account for 60% of China’s foreign assets, in which dollar assets accounted for 70%. Domestic pressure increases Does China have choices ? CASS-IWEP

2. Chinese exchange rate policy? CASS-IWEP

RMB nominal exchange rate against US dollar 2. Chinese exchange rate policy? RMB nominal exchange rate against US dollar Further appreciation of Chinese currency? A long lasting feud; Exchange rate issue should be off the table for two reasons: Shift its growth pattern and the dollar pegging aimed at boosting export will be less meaningful than before; Exchange rate is one of tools for imbalance correction, it seems to yield to another method of correction in this crisis: demand shrinking. A dramatic de-pegging is not going to happen, but a gradual band widening is very likely to be in place, for reasons: Reduce exchange rate misalignment; Serve for a wider use of the RMB in trade and financial transactions; Come along with capital account opening in order to have space for more independent domestic monetary policy.

3. Chinese further financial liberalization and opening? CASS-IWEP

China has a relative low level of financial openness (liabilities + assets /GDP) Whether China can play a greater role in financial area relies on how open Chinese financial regime is. The ongoing financial crisis provide a perfect case of market failure. Moreover, all the bailout and coordinated actions in the US and EU are pointing to the direction towards more government intervention and controls. That gave an excuse to the group of thought in China that China should slow down the speed of further deregulation and liberalization of the economy, especially over the financial sectors. CASS-IWEP

4. Chinese idea of “super-sovereign reserve currency”? CASS-IWEP

An reaction to the US huge stimulus package What is it? An reaction to the US huge stimulus package A fear for the dollar value’s further shrinking An expression of Chinese anger about current dollar standard in the global financial system A signal that China wanted to diversify its reserve assets An option for Chinese policy in reshaping a new global financial architecture Is it feasible? It’s in line with discussion on creation of “substitute account of SDR” in the IMF But as a proposal of new reserve currency, it is most likely to remain as a blueprint in a long-run. CASS-IWEP

5. China’s regional economic policy? CASS-IWEP

Why so important? Running deficit with many Asian economies. 60% intra-region trade attributed to China; A hub of vertical production distribution in Asia; Financial inflows (FDI and portfolio) are mainly form Asia. One of biggest contributors to Asian liquidity mechanism: Asian common reserve fund under the Chiang Mai Initiative. How China exerts its economic and financial influence in the region is very important for both the correction of global imbalances and also the maintenance of global financial stability. In this way, China is sharing the burden with other developed countries to help the countries in Asia. CASS-IWEP

6. RMB internationalization? CASS-IWEP

RMB is far from an international currency with many constraints. A hot topic in China, and somehow turns to be sentimental when to consider the potential loss of Chinese foreign reserves in the form of dollar assets. There are many reasons for China to do this, but the issue is how to make it happen? RMB is far from an international currency with many constraints. In terms of size and range, the use of RMB is very small, and with many limitations in locations and entities. But it really is a matter of time. RMB internationalization will be a balancing factor to the dollar dominant international financial regime. Function of RMB Public purpose Private purpose Store of value International reserves None Currency substitution and investment RMB deposits in Hong Kong Medium of exchange Vehicle currency BSAs under the CMI bilateral swap arrangements between central banks Invoicing currency Trade settlement in RMB RMB bonds in HK by policy and commercial banks RMB government bonds under ABF2 RMB equities via QFII Unit of account Anchor for pegging Denominating currency CASS-IWEP

To conclude: China alone cannot solve the problem of imbalance, because China is on one side of the equation, and being a money lender doesn’t give China a real financial power; But China has options to play a meaningful role; Overall, it is a matter of how China grows its financial influence in the regime where the U.S. is dominating. CASS-IWEP