Impact of U.S. monetary policy on China's international finance

Cross-Country Capital Flows and Currency

International Project

overseas investment .

GLOBAL INSTITUTES IN INTERNATIONAL FINANCE .

INTERNATIONAL FINANCE CORPORATION .

WORLD BANK .

WORLD TRADE ORGANIZATION

INTERNATIONAL MONTARY FUND .

INTERNATIONAL FINANCE IN CHINA .

BANKING INSTITUTES

NON-BANKING INSTITUTES

THE EXCHANGE RATE FIASCO

FINANCIAL CRISIS IMPACTS ON SINO-AMERICAN RELATIONSHIP

RECESSION'S AFFECT ON CHINA .

ASIAN MONETARY FUND .

CHINA'S TRADE POLICIES AND THEIR CONTRIBUTION TO THE FINANCIAL CRISIS

Monetary policy is the study of circulation of money, the granting of credit, the making of investments and the provision of banking facilities and international finance is studying it on an international level.[footnoteRef:2] Usually the affect can be seen in exchange rate and foreign investment and international trade. This includes the analysis of global financial markets, cross-country capital flows and currency, international projects, and overseas investments. [2: Merriam-Webster Online Dictionary: http://www.merriam-webster.com/]

US Monetary Policies have a far reaching effect on the other side of the world. Primarily due to U.S. Dollar being the reserve and default currency for trade transaction. Every time Federal Reserve decides to make a policy such as the recent Quantitative Easing (QE) where the U.S. will buy $600 billion of treasury bonds to boost economy and rising unemployment rate, economies around the global market are shaken to the core. Financing bidget deficits with simply printing more currency is not only unsustainable but impacts investors holding massive U.S. debt.

International Finance is regulated by various global institutes which tend to help the individual investors on how to deal with the global futures, options available and the Foreign Exchange (FOREX) market. China's International Finance is made up of banking and non-banking financial institutions, trade and project finance and securities markets[footnoteRef:3]. China is one of the countries greatly involved in overseas investments and trade export. However, China's capital flows are largely being affected by the ongoing recession in the United States. Both China and the United States are in a battle over intervention in the FOREX markets resulting changes in both the Chinese currency Renminbi and the U.S. dollar. [3: Ross Levine, 2002. Financial Structure and Economic Growth: Cross-Country Comparisons of Banks, Markets, and Development, MIT Press, Cambridge, Massachusetts]

2. Benefits of Global Finance

It promotes domestic investment and growth through capital imports

Its global financial institutions prevent excessive domestic regulation

It presents important information on the important areas of investments, therefore, leading to effective capital allocation

It provides the countries access to capital markets across the world

Also the worldwide cash flows help correct the bad government policies

Overall, International Finance leads to a more effective banking system through a healthy competition between countries

International Finance promotes the integration of economies helping the facilitation of easy capital flow2. This free transfer of funds will help result in more equality among countries which are part of global financial system.

3. Global Finance Analysis

The performance of global financial markets depends upon the total number of securities that are traded in each of the financial markets[footnoteRef:4]. For example, when a particular market closes with most of its securities on the higher side, then the market is said to have perform well. The global financial markets include funds from all the countries which are part of it, therefore, giving the countries access to capital markets across the world. This enables the countries to borrow during difficult times and lend during good times further assisting the country to maximize its trade finance. [4: Gregory, Neil, Stoyan Tenev and Dileep Wagle, 2000. China's Emerging Private Enterprises, International Finance Corporation, Washington, D.C.]

The present market economy is working very fast on a global scale because the investment traders do not limit trading in securities to just one or two markets in their country of residence. Instead the traders invest in many markets across the globe resulting in increased capital flow for the desired country. Because more and more companies are investing in the financial markets on a global scale, this has led to a healthy competition between countries.

-Cross-Country capital flows and currency[footnoteRef:5]. Countries with lower currency values and huge capital flow promote international finance by means of trade services such as increased export. [5: Ross Levine, 2002. Financial Structure and Economic Growth: Cross-Country Comparisons of Banks, Markets, and Development, MIT Press, Cambridge, Massachusetts]

- International projects: The participation of countries in international projects has led to an increase in the services provided by international finance, therefore, promoting its growth.

- Overseas investments: Countries investing across the globe has caused profound growth in the economy, hence, leading to an increase in the international trade.

4. Global Institutes in International Finance

The global institutes[footnoteRef:6] which regulate various aspects of international finance are: - [6: Tenev, Stoyan, Chunlin Zhang, and Loup Brefort, 2002. Corporate Governance and Enterprise Reform in China, Building the Institutions of Modern Market, World Bank, IFC.]

-International Finance Corporation (IFC): plays an important role in providing technical assistance to the businesses and governments of developing countries supporting investments in the private sector of developing countries to promote their growth. It is the main source of loans and equity financing for projects undertaken in the private sectors of the developing countries4.

-World Bank: This is responsible for funding those projects, primarily in the developing countries, which are not financed by the private sector[footnoteRef:7]. [7: Allen, Franklin, and Douglas Gale, 2000a. Comparing Financial Systems, MIT Press, Cambridge, MA.]

-World Trade Organization (WTO): This is responsible for resolving trade disputes as well as negotiating different trade agreements among its different member nations6.

- International Monetary Fund (IMF): is known as the final solution for countries in a financial crisis for example trade deficits and currency crisis. The relief amount which it offers is in relation to the country's contribution in the global trading system. It is responsible for monitoring the payments balance of its member countries6.

5. International Finance in China

China's Finance structure is regulated by banking and non-banking financial institutes[footnoteRef:8]. Banking institutes are People's Bank of China which is the central bank of China similar to the U.S.'s Federal Reserve System. It sets policies which govern specialized banks, which include the industrial and commercial banks of China. Bank of China also oversees foreign banks, which are responsible for collecting bills and remittances from overseas, discounting foreign exchange bills and arranging the documentary credit. [8: Schipani, Cindy, and Junhai Liu, 2002. .Corporate Governance in China: Then and Now, Columbia Business Law Review, Vol. 2002, 1-69.]

Non-banking institutes are International Trust and Investment Corporations which are designed to promote investment in and from China, make foreign exchange guarantees, raising funds via deposits, issue bonds and overdrafts, making short-term and long-term loans and if required then borrow from foreign banks.

6. The Exchange Rate Fiasco

Chinese Yuan had been historically pegged against the U.S. Dollar up until the July 2005. Some argue that it was undervalued by as much as 40%.

Yuan is now pegged against a basket of currencies like some of the Middle Eastern countries but after much pressure from global economic powers and mainly the U.S., the Chinese Economist have decided to slowly and gradually transition the Yuan towards a free float currency we see around the world.

It has been United States Govt. argument that Yuan is till devalued by at least 25% in a U.S. Treasury Department report. The undervalued Yuan gives Chinese exporters an unfair competitive advantage resulting in a loss of American jobs has caused hefty trade deficit, according to the report. Whereas Chinese Commerce ministry rejects the argument blaming "globalization"[footnoteRef:9]. With China remerging as a world economic and military power, it is understandable that it does not want to be seen giving in to the American pressure on revaluation of Yuan. U.S. has resorted to threats of sanctions against China on the charge of manipulating its currency. [9: "China Denies Yuan Behind U.S. Trade Gap," Manila Bulletin 16 Mar. 2010: NA, Questia, Web, 18 Mar. 2011.]

China's economic strategy is to keep the Yuan/dollar fixed as it serves as an anchor to all internal prices. But to avoid U.S. protectionist threats, China has agreed to revalue its currency at 6% annually since 2005. But the calculated revaluation discouraged capital outflows from China, which still led to huge balance of payment surplus.

People's Bank of China in order to prevent renminbi to climb upwards decided to buy dollar assets in terms of U.S. Treasury. Until July 2008 China has amassed about $2 trillion worth of fore reserves. There was still an excess supply of renminbi which inflated Chinese economy to 8% in 2008.[footnoteRef:10] [10: Ronald I. Mckinnon, "Solidifying a New G2: China and the United States Should Stabilize the Yuan/dollar Relationship," The International Economy Wntr 2009,Questia, Web, 18 Mar. 2011.]

IMF does not necessarily share the same views with United States, when IMF Manager Director Dominique Strauss-Kahn pointed that "revaluation of the renminbi goes in the right direction," it still will not solve the financial crisis[footnoteRef:11]. [11: "IMF Chief Says Chinese Yuan Still Too Low," Manila Bulletin 29 June 2010: NA, Questia, Web, 18 Mar. 2011.]

Quick growth does not come without its stretch marks, which are evident in the inflation of 4.4%. It is noteworthy that it is roughly equal to twice the inflation rate in the U.S. Chinese policy to tackle the growing inflation has been to raise interest rates, reducing export and offering tax incentives. [footnoteRef:12]Weaker Yuan has had its fallouts on reduced Chinese household income and diverting investment away from industries that serve the Chinese Consumer[footnoteRef:13]. [12: McMahon, Chris. "Forex, Trade and Politics." Futures Sept. 2007: 58+. ] [13: "IMF Chief Says Chinese Yuan Still Too Low," Manila Bulletin 29 June 2010: NA, Questia, Web, 18 Mar. 2011.]

This obviously has a negative effect on U.S. economy with huge trade deficits. There is an alternative where U.S. does not force the interest rates down, instead the unwinding strategy would drive down the U.S. export value, and consequently eradicate the trade deficit at the cost of competitors. It must be noted that exporting economies prefer a cheaper currency relative to dollar, since back home it is more value for that dollar.

Monetary Policy

A question remains whether recession has subsided and economic recovery has started, but it can be best answered by actions of Treasury complex and its interest rates outlooks. Financial crisis of 2008-2009 saw rates frozen at near zero. Now in 2010, interest rates changes will likely affect dollar valuations, economy and eventually the unemployment rate.

Before the interest rates are hiked, credit facilities offered to financial institutes to enable them to weather the crisis will be withdrawn. [footnoteRef:19] [19: Christine Birkner, "Interest Rate Policy: under Pressure," Futures Jan. 2010,Questia, Web, 18 Mar. 2011.]

China has huge influence over the interest rate fluctuation, being the largest holder of U.S. treasuries up until now. Some say that china's hunger for U.S. bonds is the major cause of interest rate policy of keeping it as low as possible. This is interpreted as a counter move from the Federal Reserve, concerned about Chinese financial clout on U.S. bond market.

At the same time, being the largest creditor to the U.S. And its fiscal structure, China is probably concerned about the viability of American economy. In fact China along with Russia and Brazil are the most vocal opponents of a reserve currency and would like to see the global economy move away from dollar and its reliance on it. Regardless of this, China continues to buy more and more dollar debt. Chinese investment in commodities has helped currencies such as Australian and Canadian to hike up against USD. China has the most to gain or lose from the movement in the value of U.S. dollar.

The Federal Reserve has claimed repeatedly that interest rates will be low in the foreseeable future. It is weighing down heavily on dollar exchange rates which will reduce to Chinese trade deficit and drive up employment rates.

The Congressional Budget Office has estimated budget deficit for 2009 to be as high as $1.18 trillion. Andrew Wilson a senior analyst at interactive Brokers predicts that "big deficit will make the cost of borrowing increase which could turn the economy into a gutter"[footnoteRef:20]. Dollar has been weakening largely to the uninhibited spending by the Obama administration, which most analyst believe is the right course of action in the current economic conditions. Healthcare bill alone will cost $1 trillion, which the govt. will pay of course with printing more currency and borrowing more and raise taxes, all resulting in a weaker dollar. [20: Christine Birkner, "Currency Outlook: Risk and Recovery," Futures Sept. 2009, Questia, Web, 20 Mar. 2011.]

Interest rates are also linked with inflation, which is a cause of concerns to all policy makers in the Capitol Hill. Higher rates will hurt the already dwindling economy, yet prolonged low interest rates will invariably result in inflation to be seen in next 3-5 years[footnoteRef:21]. All analysts agree on the likely outcome of a surge in sell off of treasury market as interest rates increase. [21: Christine Birkner, "Interest Rate Policy: under Pressure," Futures Jan. 2010, Questia, Web, 20 Mar. 2011.]

Equity markets have gained the most from the lower interest rates as trading flourishes when the dollar is weak. Stocks are being priced far better than the bonds. Any upward movement in rates will be interpreted as a sign and balance will shift away from equity.

The recovery has been slow; we have all heard that too many times already. Part of the blame must be shared by Obama's confused economic policies which send mixed signals to the financial market. Industry has taken rather personally the bashing Obama administration served immediately after the credit crunch, which plunged the economy in deep recession.

8. Recession's and Its Affect

If one were to analyze Chinese ascent to globally dominant exporter, one may make a few forecasts on how the financial crisis may impact China's economic fabric. The 8-10% growth of the turn of the 21st century has slowed a little down to 7-8% in 20093. Still China has the population and its demands to fuel its growth as the domestic consumer's purchasing power rises. From 2001, U.S. exports have increased from $19.2 billion to $71.5billions in 2008. The recession only was a little bump on the way when it dropped to $69.6 billion in 2009[footnoteRef:22]. [22: Jacob Barron, "Jobs, Exports and the Yuan: Pressure Builds on China for Currency Reform," Business Credit May 2010, Questia, Web, 18 Mar. 2011.]

Even though the recession has ended, the U.S. demand supporting its jobs has not made a comeback to its pre-recession numbers. Capitol Hill and its inhabitants are engaged in all tricks and more to bring the unemployment rate down but to no avail so far.

So far domestic consumption has not accounted for the growth rate now the Chinese are becoming a bigger consumer market as experienced during the last year's raw material demand hike. Also the employment rate has only risen by only 1% 4. The Chinese govt. faces tasks of poverty alleviation and employment growth during the financial crises.

In line with the U.S., the Chinese regime announced a fiscal stimulus, most of which is directed towards social security benefits. It targets those underdeveloped Chinese mainland provinces in the west.

There are financial capital outflows and the lack of safe financial instruments. U.S. treasury continues to be the safest of all sovereign bonds considering how the European bonds have been devalued recently.

9. Asian Monetary Fund

The thirteen ASEAN countries have decided to form a "regional currency swap scheme" which will lend each other money in times of liquidity crunch.[footnoteRef:23] This multiple currency pool will protect against past financial crisis like that occurred in 1997-8. China and Japan are contributing 32% each of this pool being the larger member of the Asian Bloc[footnoteRef:24]. This is a different Asia with lesser reliance on IMF, since the Korean loans subsidized by the IMF and its eventual burden on Korean resurgence. China is leading the way this time around, with Japan closely following its lead. [23: Jianhai Bi, "An Asian Monetary Fund? Jianhai Bi Outlines Asian Efforts to Protect Their Economies during the Global Financial Crisis and Predicts Long and Difficult Negotiations," New Zealand International Review 34.6 (2009)] [24: Jianhai Bi, "An Asian Monetary Fund? Jianhai Bi Outlines Asian Efforts to Protect Their Economies during the Global Financial Crisis and Predicts Long and Difficult Negotiations," New Zealand International Review 34.6 (2009), Questia, Web, 16 Mar. 2011.]

10. China's Trade Policies and their contribution to the Financial Crisis

A panel study by U.S. congressionally chartered commission concluded that China's aggressive subsidizing of exports though currency manipulation has laid the ground work for the Global Financial Crisis.[footnoteRef:25] [25: Panel Slams China's Trade Policies; Says Beijing Contributed to the Global Financial Crisis," The Washington Times (Washington, DC) 21 Nov. 2009: A01, Questia, Web, 16 Mar. 2011.]

China has been drifting away from the free market system it adopted in the 80s, instead it is regressing towards a tighter government regulated and controlled economy.

An illustration of a controlled market is of Chinese commercial Banks, wholly owned by the government.

11. Conclusion

China has come a long way since 90s when the leaders took some bold economic decision and embraced market reforms to regulate banks and financial institutes.

With Chinese regulation of the financial sector, it does have some advantages unlike the unregulated financial sector in the United States -- It is likely to remain stable. The same has been observed in countries which back their economic growth with solid manufacturing and export bases like Germany, Canada and Scandinavian countries[footnoteRef:26]. This strategy goes hand in hand where the regime deems banking sector of strategic importance to the nation's interests. [26: Jacques, Martin. "No One Rules the World: The United States Is in Decline and No Longer Able to Lead, but China Is Not Yet Ready to Take Its Place. This Is the Alarming Backdrop to the G20 Global Crisis Summit in London." New Statesman 30 Mar. 2009: 22+]

China has driven a point home that the decisions to retain control of certain strategic economic pillars of banking and financial markets have paid off. Banks are providers of finance and capital judiciously and not there to profit regardless of economic realities.

The U.S. Federal Reserve has stuck to its policy yet the slow recovery may give enough incentive for a creditor like China to seek better returns on an apparently risky investment.

Although U.S. has repeatedly threatened sanctions on Chinese imports, the momentum is with China. With the burgeoning domestic demand it need only figure out how to secure access to raw material and energy to supplement the exports.