FROM THE OFFICE OF PUBLIC AFFAIRS

May 18, 2005
JS-2452

The Honorable John W. Snow
Prepared Remarks to the American Iron and Steel Institute
2005 General Meeting
Washington, DC

Good afternoon; thanks for having me here today. I hope you're having a terrific meeting.

I appreciate how close you are to the pulse of markets and current events. And I know that few, if any, can match you in the steel industry for your grasp of commodities markets and materials markets, as well as a sense of long term production and capacity trends.

That's why I would like to talk today about a topic that I know is foremost in your minds… one that wasn't on our radar screens a few years ago, but is now central to world economic events: the Chinese economy and Chinese economic policy.

The three decades since the Chinese took a decisive step toward the creation of a market economy have seen a remarkable transformation of the Chinese economy.

Since 1987, Chinese growth has averaged over nine percent per year, catapulting that country from a minor player to the seventh largest economy in the world. Per capita income has more than tripled in that period and hundreds of millions of people have been lifted from poverty. Even more remarkable has been their transformation in terms of trading with other countries. China has gone from being almost cut off from the outside world to now being the 3rd largest trading country after the United States and Germany. Over the past four years China, along with the United States, has been a key growth engine for the entire world economy.

Today, as you well know, what takes place in China affects the entire world economy. That means that turbulence in China's growth – periods of acceleration and overheating of production and investment, followed by hard-landings – now have a big effect on the global economy, as well as on markets for commodities and basic materials.

There can be no doubt that much of China's growth performance is the result of the policy choices that it has made – especially its embrace of the market over central planning.  But this remarkable transformation could not have taken place without access to the world market, the open-trading system, and foreign investment. 

China benefits greatly from the world trading and financial system.   But with that role comes responsibility, which is truly the issue of the day.

First, China must live up to its WTO commitments, including: opening markets; protecting intellectual property and respecting the rules of the international trading system.

Second, China must also play its part in promoting sustained world economic growth and the adjustment to international imbalances.  This is where China's exchange rate policy is key.

China has kept its exchange rate fixed to the dollar for the last ten years.  And while a fixed exchange rate may have had benefits for China originally, that is not true today.

China's fixed exchange rate impedes the transmission of international price signals and international adjustment. It also skews incentives within the Chinese economy toward production for export and away from production for domestic demand.

Of great concern to you, I know, and to me and the President: China's fixed rate is inappropriate for the world economy.  It is also inappropriate for the Chinese economy.  It has widened regional imbalances and income disparities. It has also led to huge capital inflows that have fueled overinvestment and speculation in the property market, as well as the creation of a new generation of bad loans. The fixed exchange rate coupled with large capital flows deprives China of the ability to run its own monetary policy or alter domestic interest rates – greatly diminishing the ability of economic policy makers to avoid the cycle of boom and bust that has occurred in the past. And finally, a fixed exchange rate allows imbalances to build up and speculators to identify what becomes an increasingly sure bet.   The result is that adjustments, when they take place, are all the more disruptive.

What China needs is a more market-based, flexible exchange rate – one that responds to international price signals and facilitates international and domestic adjustment. The Chinese leadership recognizes this, and they have made a commitment to move to a market based flexible exchange rate.

This Administration has worked closely and intensively with the Chinese authorities over the past 2 years -- both at the senior policy level and at the technical level – to prepare for a more flexible exchange rate. We have also been joined by China's major trading partners and the international institutions, making clear that this is not simply a US issue.

China has taken major steps as well.  It has deepened markets for foreign exchange by liberalizing controls on transactions and surrender of foreign exchange, and by loosening controls on capital flows. China has also introduced financial instruments and trading systems to support a flexible exchange rate.

A major step actually took place today in Shanghai.  The Chinese Foreign Exchange Trading System and Reuters began operation of a new trading system that, among others things, expands the number of currencies that can be traded and allows banks to act as market makers.

Finally, China has strengthened its financial system, including the regulation of foreign exchange exposure and trading.

As a result of these efforts, China is now ready to introduce a more market-based, flexible exchange rate regime… and the time to do so is now.  Further delay would not only postpone adjustment in the Chinese and global economies, it would also add to the risks that are now building up.

Yesterday I released Treasury's annual Foreign Exchange Report.  The report contained a very careful evaluation of the foreign exchange practices of China and other economies.  While we did not find that China met the technical requirements for designation under the terms of the 1988 Trade Act, the report made it very clear that China must act soon to avoid designation in the future.

A flexible exchange rate would give China greater ability to ensure stable growth, avoid inflation and bad loan problems, and address internal income disparities. It would also facilitate smooth and rapid adjustments to imbalances, both in the Chinese economy and the global economy.

Greater exchange rate flexibility by China in particular, and by a number of large economies in Asia in general, is an important part of bringing down the US trade and current account imbalances while maintaining robust global growth.

That said, we should recognize that Chinese exchange rate flexibility is not a panacea.  The reduction of global imbalances is a shared responsibility, and each of the major economies has its part to play. The United States must cut the fiscal deficit and increase domestic savings.  We know this, and the President has made a clear commitment to cut the federal deficit in half as a share of GDP by 2009.  The Administration is also committed to increasing the U.S. savings rate… and as you know President Bush would like to see reforms of the Social Security System that give Americans more control over their retirement income.

Global imbalances are also widened by economies that are not growing as fast as they could. The economic engines in Europe and Japan, for example, have been in neutral for too long.  The European Union and Japan need to address the structural problems that limit domestic growth, so that incomes there can grow at full potential, and so that they can drive global growth forward.  Faster growth in Europe and Japan is critical to shrinking the U.S. current account deficit without shackling the global economy.

The third component is greater exchange rate flexibility in China, along with other emerging Asian economies. 

Adjustment of international imbalances and the maintenance of sustained global growth is a shared responsibility involving macroeconomic policy, structural policy, and exchange rate policy.   The International Monetary Fund has a unique role in mobilizing policy responses to international imbalances, and a unique role in considerations of exchange rate policy.  Yesterday I called on the IMF to undertake a comprehensive review of current imbalances and report on its findings.

A more flexible exchange rate for China is not a panacea.  It will not eliminate the US trade deficit.  But Chinese flexibility is part of the solution – along with flexibility of other currencies, stronger domestic-led growth in Europe and Japan, and bringing down the deficit and raising savings in the United States.

A market-based flexible exchange rate is now the next step in China's move to a market economy.  It recognizes the role that China now plays in the world economy, as well as the need for effective market economy policy tools.  It's a good step for China, and it's a good step for the rest of the world.

I'd be happy to take your questions now.