Speech - Adams on the Economic Aspects of the US-China Relationship
Location: Washington, D.C.
Author:
Timothy D. Adams
Date: Thursday, March 30, 2006
The following is the testimony by Timothy D. Adams in front of the Senate Finance Committee on the US and China relationship.
Mr. Chairman and distinguished members of the Committee, I am pleased
to be with you today to discuss Treasury's economic engagement with China,
what we have achieved and the critical work to be done. The U.S.
relationship with China may be the single most important economic
relationship of the 21st century. Underlying Treasury's engagement is the
fundamental belief that a broad, mature, candid, and constructive
relationship with China will bring results that are good for the American
people.
When Secretary Snow traveled to China last fall, he articulated the three
pillars of what China needs to do to contribute to sustained global growth
and eliminate distortions and imbalances. These are: (1) adopt a more
market-based, flexible exchange rate; (2) shift from investment- and
export-oriented growth to a more consumption-based economy; and (3) reform
and open up China's financial sector, including its capital markets.
Implementing these reforms will promote an orderly reduction of global
imbalances and lead to sustained and less volatile Chinese growth to the
benefit of its own population and the global economy.
The Chinese have made some important achievements on these three pillars,
but they still have much to do. Today I would like to describe those areas
where greater efforts are needed. The best place to begin is by discussing
more broadly U.S. economic relations with China.
China's Importance
Almost 20 years have passed since China began its transition to a market
economy, and China has seen its standard of living surge. It has gone from
maintaining an autarkic trade policy to subscribing to the WTO principles
of open and fair trade, and from being a minor player in global trade to a
major player in the global economy. China is now the world's 4th largest
economy and the 3rd largest trading nation. The United States has
benefited from China's growth: U.S. exports to China have grown at five
times the rate of our exports to the rest of the world since China joined
the WTO. Growth in exports to China has exceeded 20 percent over the last
three years and China has risen to our fourth largest export market.
Variations in China's growth rate now have a significant impact on the
global economy and a major impact on markets for steel, oil, copper and a
variety of other products. Moreover, the U.S. and China together have
accounted for almost half of global growth since 2000. A prosperous and
secure China that meets its international obligations and is fully
integrated and engaged in the global economy and global economic
institutions is in our interest, and in China's interest. It presents
enormous opportunities for U.S. workers and firms.
Economic Challenges
China's rapid growth and the character of that growth also pose challenges
for China and for the rest of the world. While China's growth has been
rapid, it has depended too heavily on investment growth and increasingly
on net exports.
Net Exports and the Current Account
Opening the Chinese economy to trade was a major factor in the development
toward a market economy in China and the acceleration of Chinese growth.
Chinese imports have grown rapidly along with Chinese exports, so that
increases in the trade surplus have until recently made only a small
contribution to Chinese growth. But the last two years have seen a
dramatic increase in China's global trade surplus from $25 billion in
2003 to $102 billion in 2005. Net exports accounted for 12 percent of real
GDP growth in 2004. China's overall current account surplus has also risen
sharply, from $17 billion in 2001 to $69 billion in 2004, and estimates
for 2005 are near $150 billion, or almost 7 percent of China's GDP.
China's current account surplus is now a major component of global
imbalances, and its continuation risks undermining support for the open
trade policies which have contributed so much to China's development.
China is now simply too large to rely on export-led growth to pick up the
slack when other sources of growth falter.
Investment
The dependence of Chinese growth on investment is even more striking. In
each of the years since 2001, investment has accounted for more than 60
percent of GDP growth. Even with the new, revised GDP figures, China's
investment is over 40 percent of GDP significantly higher than other
East Asian countries and that share is still climbing. The result is an
economy that has been skewed too heavily towards investment, much of it
with little return.
Overall productivity growth has fallen since the early 1990s, and
increased capital and labor input, rather than greater productivity, now
accounts for the bulk of China's growth. The heavy dependence of growth on
investment raises risks to the Chinese and global economy. China has a
long history of credit-fueled cycles of investment-led booms and busts. To
sustain rapid and stable growth in the future, China will need more
selective and more productive investment. Given China's current size and
integration into the global economy, the next Chinese downturn will have a
global impact, and affect U.S. jobs and prosperity.
Treasury's Intensive Engagement with China
Treasury is in frequent and substantive consultations with the Chinese
government on exchange rate and financial market reform issues. Secretary
Snow and Finance Minister Jin convened the 17th Joint Economic Committee (JEC)
meeting last October in Beijing, which covered a wide array of economic
policy, financial sector, and capital markets issues. Over the past few
years, we have broadened the JEC to include a range of senior Chinese and
U.S. financial officials, including the National Development and Reform
Commission (NDRC), and China's chief financial regulators. Treasury also
conducted the first meeting of the Sino-U.S. Financial Sector Working
Group, which brings together U.S. and Chinese financial regulators at a
more technical level. We will host the next session in April.
In 2005, Secretary Snow dispatched a high-level envoy to conduct quiet and
meaningful talks on the three pillars of our strategy, with special focus
on exchange rate flexibility. Next month, Treasury's financial attachι,
Dave Loevinger, will take up residence in Beijing. Getting more
representatives on the ground, where they can advocate for U.S. interests,
is part of Secretary Snow's initiative to place Treasury staff in the
largest and fastest growing emerging markets, and is included in the
President's FY 2007 budget request.
Two years ago, Secretary Snow launched a Technical Cooperation Program
(TCP) to help the Chinese authorities overcome the technical obstacles
they had identified to greater exchange rate flexibility. Treasury has
hosted a number of exchanges, including training on developing and
regulating financial futures markets.
Encouraging China to meet its responsibilities is a global task as it has
global implications. To leverage our own efforts, we have enlisted support
from China's major trading partners particularly through the G-7, APEC,
and the IMF.
We believe the most effective way to promote change in China, including on
the exchange rate, is by working in cooperation with our Chinese
counterparts. There are several bills in Congress that would close our
markets to Chinese goods if China does not move more on its exchange rate.
We do not support those isolationist approaches. They would damage our
economy and not achieve our shared goals.
In addition, we are reviewing the legislation Chairman Grassley and
Senator Baucus introduced yesterday and look forward to providing our
views on that legislation once our review is complete.
With this strategy in place, it is useful to take stock now of how China
has responded to the three pillars: greater exchange rate flexibility,
balanced growth, and reform of China's financial sector.
Three Priority Issues
I. Exchange Rate Policy
Encouraging China to move more rapidly to a more market-based, flexible
exchange rate regime is Treasury's number one priority. Exchange rate
flexibility is in China's interest. Greater exchange rate flexibility will
strengthen the ability of Chinese monetary policy to help assure sustained
growth, avoiding the boom-bust cycles that have characterized Chinese
growth to date. Greater ability to control domestic interest rates will
also lead to more efficient financial intermediation, and help avoid
credit-fueled investment booms and resulting buildups of non-performing
loans. As China's transition to a market economy proceeds,
command-and-control tools will lose their effectiveness, and interest
rates and other price mechanisms will become more important. The price
signals that come from a flexible exchange rate will be a critical part of
readjusting China's economy to produce more balanced and sustainable
growth. Finally, a more flexible Chinese exchange rate will help address
global imbalances, particularly as it is likely to allow other Asian
economies to adopt more flexible exchange rate regimes.
The Chinese leadership has publicly committed to greater exchange rate
flexibility. Despite internal criticism on the pace of market reforms in
China, Premier Wen reaffirmed this commitment in his press conference
following the closing of the National People's Congress on March 14,
saying China "will expand the foreign exchange market and allow more
flexibility and fluctuation of the currency."
Our engagement with China on exchange rate policy is not now about
"whether" but about "how quickly." China has made some progress in making
its currency more flexible and market-determined, starting with the
adoption of its new exchange rate mechanism last July. It has gradually
allowed more movement and flexibility. It has authorized inter-bank
trading of currency and more participants in the foreign exchange market.
China has also introduced new financial products to hedge against currency
risk, and strengthened its banks and its supervision of the financial
system.
But to date China's progress has been far too cautious. Since China began
changing its exchange rate last July, the RMB has appreciated by only 3.2
percent and the day-to-day fluctuation has been severely constrained. It
has also failed to test the limits of the current narrow intra-day trading
bands. That said, the RMB continues to be much more stable against the
dollar than it is against a trade-weighted basket of the Yen, the euro,
and the dollar (the renminbi's nominal effective exchange rate appreciated
by around 9 percent in 2005). This tight control over the exchange rate
prevents the market incentive needed to develop liquidity and hedging
instruments. And China continues to accumulate foreign exchange reserves
at an excessive pace. China's foreign exchange reserves are almost 600
percent of its short-term debt in 2004, while economists consider 100
percent coverage prudent. As a result neither China, nor the global
economy, has reaped the benefits of a more flexible exchange rate. The
Chinese government must allow market forces to play a much greater role in
the determination of the RMB's value. The obstacles are no longer
technical; China could easily move more rapidly towards greater
flexibility. It should do so now.
II. Rebalancing Growth Towards More Domestic Demand
In addition to greater exchange rate flexibility, sustaining rapid and
steady growth in the Chinese economy without the buildup of a large
external imbalance will require a more balanced pattern of Chinese growth,
with a much greater role for consumption, which is an estimated 47 percent
of GDP under China's revised GDP statistics, compared to over 60 percent
for India, 57 percent for Japan in the 1960s, and 67 percent for Korea in
the 1970s, all periods of rapid growth in those economies.
The counterpart to China's high investment and its current account surplus
is a savings rate of roughly 50 percent of GDP, which may be the highest
in the world. One World Bank study estimated that China's savings rate was
10 percent of GDP higher than one would predict from China's economic and
demographic characteristics. Chinese households save 25 percent of their
income, on average, mostly in the form of low interest-earning bank
deposits. Household saving reflects a weak social safety net and limited
access to financing and insurance; households need high savings in the
event of serious illness, disability, or to pay for children's education.
The "iron rice bowl" of cradle to grave wages and benefits is gone and a
modern social safety net has not yet been erected. Chinese state and
private firms also save heavily and invest the earnings they have rather
than paying out dividends.
China's leaders recognize the importance of lowering the savings rate and
boosting domestic demand, and achieving more balanced growth is central to
current Chinese policy. To spur domestic demand, China has placed strong
emphasis on consumption and rural development in its most recent Five-Year
Plan. To boost disposable incomes of the rural poor, the government has
recently decided to cut agricultural taxes and eliminate fees for rural
primary education. It also plans to direct more capital and social
spending to the rural sector.
There are a number of additional steps that China could take to lower
savings and boost domestic demand. Policies to encourage China's
state-owned enterprises to pay some of their earnings as dividends would
reduce their savings and their inefficient investment, and could
contribute to greater social welfare expenditure or reduced taxes.
Strengthening and increasing enrollments in public pension and health
insurance systems, particularly in rural areas, are also important steps.
Increasing the range of financial products available to households is also
a critical component. Household saving could be reduced by insurance
policies covering disability and catastrophic illness, by the ability to
finance education and other major expenses, and by making higher return
investment options available to households, including those overseas.
III. Financial Sector Reform
This brings me to the third pillar of our strategy financial sector and
capital markets reform. Inefficient financial intermediation remains the
Achilles heel of the Chinese economy. China's financial institutions were
built as an appendage to the planning system, their funds still go
primarily to state-owned enterprises. The large amount of non-performing
loans reflects the failures of the planning system.
There has been notable progress on banking reform. In the last 18 months,
foreign strategic investors including U.S. institutions such as Bank of
America and Citigroup have invested more than $17 billion in Chinese
banks. In addition, international institutional investors invested around
$11 billion in the Hong Kong IPOs of two of China's five largest banks. On
the regulatory front, China has been tightening its risk classification
system for bank loans, deregulating bank lending rates, and developing
financial-sector infrastructure, such as the nationwide credit bureau
launched in January and a deposit insurance system expected later this
year.
China has also undertaken a number of steps to develop its capital
markets. Reforms to reduce the overhang of non-tradable (predominantly
government-owned) shares are moving forward. China expanded the Qualified
Foreign Institutional Investor (QFII) program to allow more access for
foreign investors to companies listed on local stock exchanges and has
also launched a separate program to allow large, long-term strategic
investors to purchase local shares above and beyond the QFII program. U.S.
securities companies are also benefiting from Chinese equity offerings
overseas. In 2005, Chinese companies raised more than $25 billion in
equity in Hong Kong alone, and U.S. securities companies (such as Morgan
Stanley, Merrill Lynch, Goldman Sachs, and JP Morgan) were the lead
arrangers for 44 percent of those issuances. Assuming underwriting fees of
between 3 percent and 5 percent, U.S. securities companies earned between
$335 million and $560 million in revenue from leading these Chinese equity
offerings.
Despite this progress, much needs to be done to improve China's financial
markets. China's stock markets are still too often viewed as a way to keep
inefficient state enterprises afloat rather than as a way to channel
capital to the most competitive firms and sectors and a way to transfer
control to more productive owners. Deeper bond markets would reduce
corporate reliance on state-controlled lenders and more active derivatives
trading would allow firms to better manage risk. On the banking side, the
state dominates: government entities own all but one Chinese bank, and the
central government's "Big 4" banks account for more than half of financial
sector assets. This pervasive state involvement has led to inefficient
allocation of resources and a large build-up of non-performing assets.
To help modernize China's financial system and capital markets, Treasury
has identified a number of priorities. First, we believe it would be in
China's best interest to allow more competition and market forces into the
sector, in particular, by eliminating ownership caps on foreign stakes and
expanding the scope of products they can offer.
Second, China's regulators and firms need to improve capacity for risk
management. This involves better accounting and financial reporting, and
institutions such as an effective nationwide credit bureau accessible to
all financial services providers (including foreign banks and other
non-bank financial companies). An essential component of this effort will
be to establish a consolidated supervision framework for financial
institutions in China.
Third, China needs to improve opportunities for private companies to
obtain finance so that capital can be channeled to its most productive and
efficient uses and support more balanced growth. In the corporate bond
market, we have encouraged the authorities to eliminate duplicative
government approvals and move to a more disclosure-based system. Such a
system will require professional institutional investors and independent,
credible credit rating agencies. On the equity market side, we are arguing
for an end to the moratoriums on new listings and sales of domestic
securities companies to foreign investors. Finally, China needs to
continue to privatize its extensive portfolio of state-owned enterprises.
We are also pressing China to make substantial new commitments in
financial services as an essential element of any Doha agreement. China
can open its financial system to competition by improving its WTO offer to
allow 100 percent foreign ownership of subsidiaries, whether by new
investment or acquisition, and allowing them to perform a full range of
securities and asset management services. China's plan to open completely
the banking sector to foreign participation by the end of 2006 is a key
WTO commitment and something that Treasury will watch closely to ensure
that regulatory impediments do not undermine China's meeting its
commitment.
Another important area of engagement with China is protecting China's
financial system from abuse. Overall, the U.S. has been favorably
impressed by the political commitment to anti-money laundering and
countering the financing of terrorism (AML/CFT) issues demonstrated by
Chinese authorities. The U.S. is working in cooperation with the Chinese
financial authorities to update their current legal provisions and improve
regulations in their financial sector to combat money laundering and
terrorist financing. These continued efforts will help reduce fraud and
tax evasion, and help improve Chinese banks' access to other markets. We
have been working closely bilaterally and multilaterally with the
Chinese authorities on these issues in order to ensure that China joins
the global community in adopting and implementing the international
standards to combat money laundering and terrorist financing.
China must strengthen its draft AML law, as it falls short in some key
areas, such as its definitions of money laundering offences and rules for
financial institutions to identify the beneficial owners of accounts.
Finally, let me address the concern of some members of this committee
regarding China's holdings of Treasury securities. Chinese holdings are
3.2 percent of the $8.2 trillion in total public debt outstanding, or 6.6
percent of the $4.0 trillion in total privately held public debt
outstanding. China has purchased around $34 billion in Treasury securities
in 2005. This is in the context of the extraordinarily deep and liquid
Treasury market where daily turnover exceeds $500 billion. China holds
only about $470 billion, or 2 percent, of a total of $23 trillion in U.S.
credit market debt securities.
Conclusion
China continues to undergo a historic economic transformation. Developing
a constructive and mutually-beneficial economic relationship with China
now is vitally important since the decisions we take in the next few years
will guide the U.S.-China relationship over the next generation and the
shape and pace of global growth for years to come. As a significant member
and beneficiary of the international economy, China should make a greater
contribution to sustaining strong global growth by reducing its large
current account surplus and working to maintain global support for open
trade and investment. To put it simply, China must play be the rules of
the system. Failure to do so entails consequences both for China and for
the global economy. It is important that we manage our relations in a way
that preserves global growth and maintains an open trade and investment
policy, which is a "win-win" proposition for both economies. The U.S.
Treasury is committed to promoting a path of mutual prosperity and global
leadership in our economic relations with China.
Thank you for this opportunity to appear before the Committee. I am happy
to take your questions.