September 15, 2005
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Remarks of Under Secretary of the Treasury Timothy D. Adams before the U.S.-China Business Council

I'm pleased to be here. I'd like to first speak broadly about U.S. economic relations with China.  After all, 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, and China's, interest.

China's Importance

Let me begin by saying that the driving force behind all of the Administration's international economic policies is the principle that rapid growth, at full potential, around the world is the most effective way to create jobs, raise incomes, and pull countries out of poverty.  In the last 25 years, the Chinese economy has made a remarkable transformation from a centrally planned system to an increasingly market-oriented economy.  China has posted an average annual real growth rate of 9.7 percent between 1990 and 2003.  China is now the world's seventh largest economy (based on market exchange rates), and because of both its rapid growth and size, one with tremendous impact on global markets.  Indeed, the United States and China have been the engines of the global economy, accounting for half of global growth in the last few years.

And as the Council membership knows, China is also the world's third largest trading economy.  China is not only a major exporter, but also a significant market for other countries' exports.  U.S. exports to China alone have grown 81 percent over the last three years.  For these reasons our economic relationship is a key lever in addressing global economic imbalances.

Addressing imbalances in the global economy is a shared responsibility among the major economic regions of the world.  Each need to take steps to help ensure that adjustments take place in an environment of high, rather than low, growth.  For the United States, this means raising domestic savings, in part, by cutting the budget deficit.  But our action alone will not be sufficient to unwind global imbalances without a major slowdown in global growth.  For Europe and Japan, addressing imbalances means further deregulation of services, goods, and labor markets to raise domestic demand.

We think there are three key elements for East Asia and China in particular: 1) greater exchange rate flexibility; 2) shifting from export-oriented growth to a domestic demand-based economy; and 3) development of the financial sector including capital markets. 

Exchange Rate

The issue that has attracted the most press and public attention is exchange rate reform.  Treasury has promoted greater exchange rate flexibility because we have always believed that it is first and foremost in China's interest.  Giving monetary authorities greater control over interest rates, and other market-based tools, while relying less on direct administrative controls, will lead to more efficient financial intermediation and reduce the risk of a repeat of the boom/bust cycles experienced in the 1980s and 1990s.  Given the significant structural changes that China's economy will undergo in the years ahead, allowing markets to drive China's exchange rate will help reduce the risk of misalignment and facilitate smooth and efficient adjustment.

However, given the high import content of Chinese exports, we know that by itself reforming China's exchange rate will not cure global imbalances.  But, increased Chinese exchange rate flexibility will lead to increased exchange rate flexibility in the rest of East Asia.  And when added up, this should have a meaningful impact on global imbalances.

In this context, the July 21 move by China to adopt a more flexible exchange rate was welcome, and has created a mechanism that over time will create room for considerable movement in the currency.  At the time the announcement was made, Treasury took special note of China's objective of allowing the market to fully play its role in resource allocation as well as "to put in place and further strengthen the managed floating exchange regime based on market supply and demand."

It was this promise of greater exchange rate flexibility and a closer alignment with market forces that was the critical part of China's action.  The People's Bank of China has also expanded the range of companies that can trade in the foreign exchange market and can buy and sell foreign exchange forward contracts - actions clearly designed to accommodate greater flexibility.  What is important now is that China allows the new exchange rate mechanism to move more closely into alignment with underlying market forces.   We at Treasury are monitoring this process closely as we continue and intensify our engagement with the Chinese authorities.

Domestic Demand

The second component of adjustment in China and East Asia is promoting domestic demand-driven growth.  According to the IMF, exports of emerging Asia have grown by 10.5 percent per year on average over the past decade, reaching 18 percent annual growth during 2002-04.  Exports now account for 45 percent of emerging Asia's GDP.  This export-led growth has resulted in surging current account surpluses, and is a major source of tension among Asia's trading partners. 

To sustain growth, China and East Asia need to spur the growth of domestic demand and reduce their reliance on exports.  A number of measures are available to China to boost domestic demand.  One solution is to reform and strengthen China's pension system, healthcare system, and social safety net so that households need to save less for unexpected events and can consume more.  Financial service liberalization and increased openness to foreign financial services providers can provide innovative financial products that can better meet households' saving goals.  And this is where I'd like to turn to next.

Financial Sector Reform

The third component is the critical issue of financial sector reform. Reform is needed given the history of highly inefficient financial intermediation.  Indeed, a more efficient financial sector will better intermediate savings and will also help in pursuit of the goal I just discussed, which is China's transition to consumption-led growth and away from a heavy reliance on the export sector.  Regarding financial sector reform let me focus on three aspects.

First is liberalization of the financial sector.  Opening China's financial services sector further by allowing overseas securities firms to establish wholly-owned subsidiaries and by expanding the scope of products securities firms can offer would add liquidity and transparency to the capital markets, increase the flow of capital to the most productive Chinese firms, inject management expertise, encourage regulatory reforms, and introduce best-practices for technology, risk management, and control systems.  Improvements in corporate governance in the financial sector will also promote the private sector role in banking. 

Second is the move to risk-based lending.  Last year's deregulation of lending rates will allow banks greater scope to differentiate borrowers based on risk.  But more reforms - such as introducing rigorous credit analysis procedures, improving accounting and financial reporting standards and adopting a strong board and corporate management structure -- are needed to better assess risk, improve asset quality and take advantage of higher interest rates to slow excessively aggressive asset growth.

Third is capital market development.  Further development of China's equity and bond markets would lead to more efficient allocation of capital, provide greater support for market oriented reforms (as agents would not be so dependent on the government to limit risks), and improve corporate governance.  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. 

Foreign direct investment in the financial sector specifically would strengthen risk assessment and management in addition to providing capital.  China's plan to open the banking sector by the end of 2006 is ambitious and something that Treasury will watch closely so that regulatory impediments do not undermine China's WTO commitments.  Particularly welcome is a recent statement from China's chief banking supervisor that a proposal is in the works to lift caps on foreign ownership of Chinese banks.  We will continue to press China to open up more to FDI in securities markets, because open economies are strong and resilient.

Treasury Activities

As is obvious from the items I've just discussed, we are actively engaged with our Chinese counterparts.  The economic transformation underway in China places tremendous demands on the Chinese economic leadership.  It also means that we need to efficiently deploy Treasury's resources to anticipate and respond to developments.  You may already know about the Technical Cooperation Program (TCP) that Secretary Snow launched two years ago.  In short, the TCP was designed to help the Chinese authorities overcome the obstacles they see to greater exchange rate flexibility at the technical level. 

Treasury has hosted a number of exchanges between our banking and securities regulators and their counterparts in China to discuss a variety of regulatory and safeguard issues surrounding a shift to a more flexible exchange rate regime.  For example, we've conducted training on developing and regulating financial futures markets in China with the aim of helping the Chinese authorities introduce currency hedging products in an environment of greater exchange rate volatility and learn how to supervise currency risk in banking systems.  We plan to continue these efforts and expand on the range of issues I've laid out today.  Over the coming year we expect to have numerous interactions with our Chinese counterparts in both bilateral and multilateral fora.  And we will use these opportunities to stand with our colleagues at USTR and Commerce in pressing China to abide by its WTO commitments, particularly protections for intellectual property.

Conclusion

Thank you again for giving me the opportunity to share with you some of Treasury's work on China.  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. 

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