Key Trends in Globalisation

Facts confirm that liberalising China’s capital account is dangerous

For some time a debate has been taking place between economists pointing to the dangers of rapid liberalisation of China’s capital account, such as Yu Yongding and internationally Joseph Stigliz, and those supporting it. Recent negative events affecting China’s economy clearly confirm that those opposing rapid liberalisation of the capital account were correct. But it is crucial to understand the reasons for these current trends not only from an immediate but from a fundamental economic viewpoint.

Current trends affecting RMB internationalisation

In superficial terms two apparently contradictory trends regarding RMB internationalisation recently occurred. First, in a positive development, the RMB overtook the yen to become the fourth most used currency in international payments. Second, clearly negative trends developed related to China’s position in the international economy. China’s foreign exchange reserves fell by almost $500 billion in only just over a year, from slightly under $4 trillion in June 2014 to $3.5 trillion in August 2015, international analysts point to clear evidence of exit of capital from China unconnected to fruitful investment, and the small two percent RMB devaluation in August sent shock waves through the global economy and was followed by further losses to China’s foreign exchange reserves to attempt to stabilise the currency.

But the apparent contradiction between these ‘positive’ and ‘negative’ trends is only apparent. Both reflect fundamental features of China and the international economy. If RMB internationalization is pursued as a very gradual and organic process this produces positive trends. If unnecessary forced attempts to internationalise the RMB are made, particularly if these are made in pursuit of other agendas, these can be significantly dangerous to China’s economy. Examination of the experience of other countries and of economic theory explains clearly the processes taking place.

Place of the RMB in international payments

Starting with the facts, Figure 1 shows the RMB’s place within global payments system. The dominance of the dollar and the RMB’s peripheral position is clear. The dollar accounts for 44.82% of international payments. Dollar dominance becomes even clearer if it is understood that the 27.20% figure for the Euro is very artificially boosted by its use for payments within the Eurozone – an economy which is internationally divided but only approximately the size of the US. If Euro payments within the Eurozone were excluded, as are dollar payments within the equivalent size US economy, the true global dominance of the dollar would be still greater.

The dollar’s role has also risen further in the recent period – its percentage use in international payments increasing from 38.8% in January 2014 to 44.8% in August 2015, while the Euro’s share fell from 33.5% to 27.2%.

Turning to the RMB, global payments in dollars are 16 times greater than the RMB’s 2.78%, and payments in dollars and euros combined are 25 times greater than those in RMB. Talking of the RMB being ‘in fourth place’ in international payments behind the dollar, without stating the gap between the two, may be correct but is substantially misleading because it distorts the correct sense of scale - there is no comparison between the position of the dollar and the RMB in international payments, and in these terms the RMB is a very minor currency compared to the dollar.

Figure 1

 

RMB internationalisation and trade

This gap between the dollar and the RMB becomes still clearer, and the explanation of the apparently contradictory economic trends referred to earlier becomes evident, if it is understood that the RMB is primarily used internationally in relation to China’s trade – functioning as a useful ‘hedge’ against currency fluctuations. By April 2015 31% of payments between China (including Hong Kong) and the Asia-Pacific region were in RMB – which primarily accounts for the RMB’s 2.78% of global payments. Such trade operations make limited overseas accumulation of RMBs necessary, and are a soundly based and healthy development reflecting China’s position as the world’s largest goods trading nation. They require, as has been allowed, convertibility of the RMB for current (including specifically trade) transactions.

But aside from this useful function the RMB’s role in international payments is still peripheral and for fundamental reasons analysed below cannot be substantially expanded rapidly. For example by the end of 2014 63% of all countries foreign exchange reserves were in dollars, 22% in Euros, and only 1% in RMBs.

It is sometimes argued that the RMB’s international role is certainly currently small but it is increasing and could grow rapidly, for example, if later this year the IMF during its regular review includes the RMB in the currency basket for its Special Drawing Rights (SDRs).

But this argument confuses holding reserves for the purpose of current operations (including trade) with holdings for capital transactions – including official foreign exchange reserves. The RMB certainly should be included in the SDRs basket of currencies due to China’s position as the world’s second largest economy, at current exchange rates, and the world’s largest goods trading nation. But this will not change anything fundamental in terms of international payments. SDR’s are not a currency nor a claim on IMF funds – they are only a claim on IMF member’s currencies. SDR’s can essentially only be part of countries’ foreign exchange reserves, and constitute less than 3% of their total. In practical terms SDR’s are essentially only an accounting unit, playing virtually no role in actual transactions.

Fundamental features of the monetary system

Confusion on the difference between the requirements for trade and other current transactions, compared to those for establishing the RMB as a major international capital unit, have created destabilising calls for too rapid liberalisation of China’s capital account. These can be best understood by looking at the most fundamental features of the international monetary system.

Economic theory, fully confirmed by the experience of other countries, shows that liberalisation of China’s capital account will not lead to a balanced flow of funds in and out of China, but only to large scale exit of capital from China. This would reduce China’s economic development via simultaneously decreasing funds available for investment in China and raising interest rates, and leading to further falls in China’s foreign exchange reserves if currency interventions are made to try to prevent the RMB’s exchange rate declining faced with these capital outflows.

The reason why in the absence of capital controls there will only be a net one way flow of funds out of the RMB and into the dollar is rooted in the most fundamental features of the monetary system.

All markets, including the global economy, can only operate with a single price standard which requires a single price unit. Money is fundamentally different from all goods and services. A market economy necessarily can only operate according to the ‘law of one price’ – i.e. it operates to produce a single price across a market (once transport and other transaction costs, tariffs and other legal barriers etc are taken into account). The reason for this ‘law of one price’ is that the existence of different prices for the same product entails an ability to make profit by utilising these, and therefore arbitrage operations will develop to exploit such differences - thereby eliminating this profit and ensuring the tendency for a product to be sold at a single price.

But a single price necessarily requires a single price standard – which is its monetary unit. If more than one price standard operated then arbitrage between different prices would either eliminate these differences, creating in reality if not in name a single measuring unit, or if different price standards existed fundamental instability would make it impossible for the market to function efficiently. An efficiently functioning economy therefore can only have a single universal price unit – prices cannot be set 20% by one monetary unit, 35% by another monetary unit, 45% by another unit etc. Consequently no mature country can nor does function with different currency units operating within it.

For exactly the same reason if any attempt were made to introduce different units for measuring international prices then either arbitrage would bring them into a single system, de facto creating a single international currency unit, or the market could not function – different markets with different national currency systems would then have to be prevented from meaningfully interacting. But as international division of labour is one of the most powerful forces increasing economic development any strong limits on different countries economically interacting would produce a huge regression of the productive forces – as was practically confirmed during the only modern peacetime period when such disruption of the international payments system occurred, the 1930s Great Depression.

Demand for the dollar

This necessity of a single price standard in turn determines the demand for foreign currencies, including for foreign exchange reserves. A relatively few individual companies seek to profit from relative movements in currencies, but globally this is a peripheral activity. The goal of most foreign exchange holdings is to possess the unit used to price international transactions – which is the dollar. This is the goal of central banks’ foreign exchange reserves but also the safest form of fundamental currency hedging by companies. Consequently if countries’ capital accounts are liberalised the net flow is always into dollars – as factual global experience since international capital account liberalisation began seriously in the late 1970s confirms.

The fundamental reason the US supports, and strongly presses, for liberalisation of capital accounts is precisely because of this one way net flow of funds into dollars. By the 1970s the US balance of payments passed into a sustained and large deficit which has continued to the present - reflecting a decline in US competitiveness. Attempts to restore US competitiveness by dollar devaluations in the 1970s, however, created political instability due to the reduction in the living standards of the US population this created – Nixon was forced from office in 1974 and Carter lost the election of 1980. The only way for the US to simultaneously run a balance of payments deficit, which other things being equal would lead to dollar devaluation, while preventing that devaluation occurring is to find a source of capital inflows into the US.

Pushing for liberalisation of capital accounts on a global scale was the US means to secure this solution to its combined economic and political problem. Given the fundamental structure of the international monetary system already demonstrated liberalisation of capital accounts necessarily created a one way net flow of funds into the dollar which has continued until the present.

The essential role of capital account liberalisation is therefore to ensure a net flow of funds from other countries into the dollar, thereby solving the US problem of having an internationally uncompetitive economy, shown in a balance of payments deficit, while avoiding the political unpopularity in the US that results from dollar devaluation.

History of the international monetary system

This fundamental theoretical economic principle that the international economy, like any market, must operate according to a single price standard is entirely confirmed by hundreds of years of operation of the global market. Although the world economy, the most complex market, has developed for several centuries during this prolonged historical period only two systems of international payments have existed. The first, from near the origins of the global market until 1931, punctuated by only a short interlude, was the gold standard. The second, from 1945 until the present, was the dollar standard. The only periods in which neither system functioned, the immediate post-1914 period and from 1931-1945, were marked by the most cataclysmic crises in the global economy’s history – the two World Wars.

The fact that there can only be a single price standard also necessarily determined that the transition from the gold standard to the dollar standard took place in historical terms almost instantaneously - the interregnum between the two was marked by the greatest disorder and conflicts in world history, and that the two systems did not overlap in time as it was impossible for two price standards to exist simultaneously.

The US, of course, understands that due to these fundamental economic forces liberalisation of capital accounts could also be a powerful tool for subordinating other countries policies to the US. This can be attempted even for what are in practice relatively small changes. Bloomberg, an overtly US neo-con publication, tried to argue: ‘To win the SDR prize, China will have to press on with plans to open its capital account - a reform that stands to shake up industries and the way Chinese companies do business.’ Martin Wolf , Chief Economics Commentator of the Financial Times, noted: ‘If China’s capital account were to be fully liberalised, the government would lose its grip on the most effective of all its economic levers.’

China cannot cheat on or be an exception to these fundamental economic laws. It is for this reason that as China moved to liberalise its capital account the data shows destabilising movements out of the RMB into dollars began.

China’s foreign exchange reserves should have been increased by China’s trade surplus rising sharply from $306 billion in the year to August 2014 to $540 billion in the year to August 2015. But instead of rising data shows China’s foreign exchange reserves fell at a rate much faster than was caused by productive Foreign Direct Investment (FDI) outflows. During 2015 China’s foreign exchange reserves have fallen by an average $36.5 billion a month and the rate of decline has risen sharply – August’s fall was $94 billion. This demonstrates large scale capital outflows are taking place with negative consequences for China’s economy.

The reasons for the trends noted at the beginning of this article are therefore clear, as is also why their ‘contradictory’ nature is purely apparent. The positive effects of the RMB’s use in relation to international trade has led to it organically becoming the fourth largest currency for international transactions – a healthy process which should be allowed to continue via RMB convertibility for current transactions. But failure to accurately recognise the nature of the international capital system, which can only create flow of into dollars, has led to overhasty relaxation of capital controls with negative effects for China’s economy.

*   *   *

This article was originally published in Chinese by Sina Finance.

A Note for Jeremy Corbyn - How China made the world's largest contribution to human rights

By John Ross

I supported Jeremy Corbyn’s election as leader of the Labour Party. As I have known him for thirty years I know Jeremy Corbyn is the most principled leader of the Labour Party in my lifetime – the most committed to human well-being. On Tuesday he is scheduled to have a personal meeting with Xi Jinping during the latter’s British visit.

The significance of China’s contribution to human well-being can be understood by both Jeremy Corbyn and the left in the US and Europe.

On key issues for the development of China, Britain, and other countries Jeremy Corbyn has the same positions as China. He is an opponent of any US military build-up against China and of proposed measures in trade agreements such as the TransPacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP) which are against the interests of the population of the participating countries, China and developing countries in general.

Sections of the British media present a supposed choice that Britain has to choose between either pursuing purely economic interests or criticising China over ‘human rights’. This posing of the issue is totally false - China should be supported precisely because of its contribution to human rights. China has done more to improve the overall situation not only of its own people but of humanity than any other country in the world - as the facts show.

Taking the latest World Bank international definition of poverty ($1.90 daily expenditure at 2011 internationally comparable prices) from 1981 to 2010, the latest data, China has raised 728 million people from poverty. The rest of the world reduced poverty by only 152 million people. China therefore lifted almost five times as many people out of poverty as the rest of the world put together.

To demonstrate what this means for humanity’s well-being 728 million people is more than the population of the EU, more than the population of the Latin American continent, more than twice the population of the US, and 11 times the population of Britain.

For someone with Jeremy Corbyn’s concern for humanity, particularly the least privileged within it, this is the best imaginable news.

Nor is this a gigantic step forward just for China but for human well-being. China’s entire population, not just the poorest, has seen increases in living standards which are without comparison in human history. China’s average annual increase in ‘total consumption’, including not only direct household living standards but education and health spending, has been over eight percent a year for three decades – not only the world’s fastest but by far the most rapid increase in living standards for the greatest number of people in human history. China has brought social security protection to 820 million people, more than the population of the EU, and health care to over a billion – three times the population of the US, almost the population of Africa, and nearly twice the population of Latin America.

The simple but gigantic example of women in China and India graphically illustrates the real issues involved in human rights globally – and women in China and India together constitute one in every five people on the planet. A Chinese woman’s life expectancy is 77 years, and literacy among Chinese women over the age of 15 is 93%: an Indian woman has a life expectancy of 68 and literacy rate over the age of 15 is 66%. India may be a ‘parliamentary republic’, in which Facebook may be used, but (regrettably for India) the human rights of a Chinese woman are far superior to the human rights of an Indian woman.

This presents the issue of human rights in the clearest fashion. The most pressing questions facing the overwhelmingly majority of the world’s population, who live in developing countries, are not those of Western ‘human rights’ campaigns such as those of ‘Amnesty International’. Over 500 million people in India do not have a toilet - for those who live in the real world to have a toilet is a far more important human right than internet restrictions. And if Indian women had the right to move to China, and would live nine years longer and achieve literacy by doing so, innumerable people would move north of the Himalayas – and that is said by someone who wants nothing but for India to make the same progress China has achieved.

Do these gigantic achievements in human rights in the real sense mean China has no problems? Not a single serious person in China believes this. To take merely some striking issues, major environmental damage exists in China. But despite this real issue overall China’s social and environmental conditions demonstrate that great progress has still been made. Life expectancy, as Nobel laureate Amartya Sen has demonstrated, is the most sensitive of all indicators as it sums up all different pluses and minuses in social, environmental and other indicators. A person in China lives three years longer, and someone in the US two years less, than would be expected from their respective per capita GDPs – showing overall social and environmental conditions in China are significantly better than would be expected from its stage of economic development and in the US significantly worse. But that does not alter the fact that China still has to take huge steps to overcome environmental problems.

Furthermore despite China’s unprecedented achievement in the reduction of poverty, it still has to finish the job by raising another 100 million people out of poverty. It would therefore be highly interesting for Jeremy Corbyn to discuss with Xi Jinping the President’s recent pledge to complete the task of eliminating internationally defined poverty in China by 2020.

As China is still building up its social security system towards the level made possible in Britain and other advanced countries, and as international studies show Britain’s health service to be the world’s most cost efficient, a mutually valuable discussion could take place between Jeremy Corbyn and President Xi on how, taking into account their countries different conditions, both can strengthen their health services.

But what China has no need of at all, indeed what is grotesque given China has produced the greatest improvement in human conditions in human history, is to be delivered sanctimonious lectures by other countries – particularly those whose recent activities include invading other countries, such as Iraq, resulting in hundreds of thousands of deaths spreading chaos throughout the Middle East, or whose historical relation to China was to force it to import opium, to burn its greatest architectural achievements, and for a century and a half to hold islands off its coast as a colonies.

I cannot put words in someone else’s mouth, but my summary of the basis for an honest discussion with China would be roughly the following: ‘President Xi, the world rightly greatly admires China’s progress in the improvement in the conditions of human beings, of human rights in the real sense – which are the greatest of any country in the history of the world. We should discuss how other countries can draw lessons from these achievements.

‘As you yourself have pointed out China, as it is still a developing country, still has long path of development ahead. You have set out the “goals of completing the building of a moderately prosperous society in all respects by the centenary of the CPC in 2021 and building China into a modern socialist country that is prosperous, strong, democratic, culturally advanced, and harmonious by the centenary of the PRC in 2049 so as to realize the Chinese Dream of the rejuvenation of the Chinese nation." Could you outline this in more detail? And in the same way we study your achievements in improving the conditions of not only China but humanity there may some aspects of our experience China may draw lessons from?

‘I particularly noted your statement of what China sees as its relation to the overall condition of humanity: "Throughout 5,000 years of development, the Chinese nation has made significant contributions to the progress of human civilization… Our responsibility is… to pursue the goal of the rejuvenation of the Chinese nation, so that China can stand firmer and stronger among the world’s nations, and make new and greater contributions to mankind."

‘Britain is also one of the world’s great historical nations. I love my country deeply, and the enormous contributions it has made to world culture and science, and in which struggles such as the Suffragettes or to create our health service are a source of great pride. There are regrettably some things in my country’s history, as with every great state, which I am not proud of. Some of these I mentioned and were crimes done by Britain to China. It is therefore particularly gratifying that this negative past can be put behind and China and Britain can now work in conditions of equality and mutual respect. On that basis, in the very different conditions of the two countries, we can both make further contributions to what must be the goal of any country’s policy – the improvement of the condition of human beings, of human rights in the deepest sense, including the right of each country to pursue its own national way of life. On that basis, as with China, my hope is that Britain will not only improve its own conditions of life but make new and greater contributions to humanity.’

Jeremy Corbyn is totally devoted to the interests of humanity, and in particular to the least privileged within it. He can therefore make up his own words. But any balanced reflection on human values will make clear that not only he but the world should rejoice to see that China has been able to take the greatest step forward for real human rights of any country.

Xi Jinping's visit to Britain - bases for a real & not only formal 'win-win' relation

This article originally appeared at China.org.cn.

*   *   *

Xi Jinping's state visit to Britain from October 19 to 23 is important in itself, clearly illustrates the basis for mutually beneficial relations between different countries and shows principles for overcoming problems between states.

There are striking differences between China and Britain. China has the world's largest population, the world's largest economy in Parity Purchasing Powers (PPPs), and is a country increasing in global weight and clearly only at the beginning of its rise. The UK has approximately one-twentieth the population of China and a significant economy although outside the 'superheavyweight' league of the US and China - its GDP being 10th in the world in PPP terms.

For many centuries Britain was the world's largest economy and most powerful state, but this position has been taken by the US and increasingly by China. Thanks to Britain's long period of development it retains a standard of living China is still growing towards – Britain's per capita GDP in PPPs is almost three times as high as China's.

However, it can be not national similarities that can create the most fruitful interaction but differences. Xi Jinping's visit will illustrate that.

Starting with the economy, China has become the world's industrial producer, the largest goods trading nation and runs a large surplus on manufactured trade. Britain has undergone one of the world's sharpest declines of manufacturing as a proportion of its economy and has been running deficits on manufactured trade for decades; however, it has a large trade surplus in financial and other services.

Even within manufacturing the contrast is striking - Britain's remaining manufacturing sector is concentrated in very high value added products, such as pharmaceuticals, while China is the world's most competitive producer of an increasingly broad range of manufactured products. The result is the two economies are complementary and vividly illustrate the international trade principles of division of labour and comparative advantage.

Due to these complementary features the economic interaction between the two countries is dynamic. Britain is China's second largest EU trading partner, while China is Britain's fourth largest trading partner. Britain is the second largest recipient of China's foreign investment within the EU and the second largest EU investor in China. Trade between the two countries in 2014 rose by 15 per cent.

The UK now sees opportunities to use its position in global financial services to win Chinese business. London is the world's largest foreign exchange dealing centre - bigger than New York and Tokyo combined. This puts London in a strong position to help establish the RMB as an international currency, a development also in China's interest. It is reported London will become the first centre outside China in which Chinese government RMB denominated debt will be issued.

China is highly interested in using its expertise and finance to invest in UK infrastructure projects. Over a fifth of Britain's power generation capacity will be replaced in the next decade, and on a recent trip to China British Chancellor of the Exchequer George Osborne announced opening of bidding for the country's projected $17 billion High Speed Two rail link - contracts potentially of great interest to China which now has the world's largest high speed system.

The opportunities for cultural, educational and 'people to people' exchanges are also enormous. Shakespeare, Agatha Christie, Harry Potter and other classic and modern British icons are well known known cultural imports in China. Britain's knowledge of modern Chinese culture is not yet as good as it should be, but enormous queues for exhibitions such as the British Museum's exhibition of the Xi'an terracotta warriors show deep interest in Chinese classical culture, while China's rise will produce increasing knowledge of China's modern achievements. More Chinese students study in British universities than from any other foreign country, for example.

Unfortunately a few years ago these potential benefits were blocked by ill-judged moves by Britain. Prime Minister David Cameron held a meeting with the Dalai Lama – a person pretending to be a purely religious figure but who actually leads a separatist political movement. This was an intervention in China's internal affairs and contrary to Britain's unequivocal recognition of Tibet as part of China. It was rather like de Gaulle's notorious 'Vive Le Quebec Libre!' declaration regarding Canada. This naturally led to a frost in relations – China refusing to hold high level meetings for over a year.

Both sides lost from this, but as China is a rising economy Britain lost more. Fortunately the British government reversed this approach and no further meetings have been held, and relations warmed. David Cameron visited China earlier this year and on his recent visit George Osborne declared Britain wanted to be China's 'best partner in the West.'

Now, Britain is doing everything possible to overcome previous problems in relations and China has responded. Both sides gain.

From going through a difficult period China-Britain relations currently are a model of how countries should interact. Regarding cultural and human interaction the situation was very accurately observed by China's President:

'Civilizations are equal, and such equality has made exchanges and mutual learning among civilizations possible… No single civilization can be judged superior to another… Every civilization is unique…. All achievements of civilizations deserve our respect and must be cherished. History proves that only by interacting with and learning from others can a civilization enjoy full vitality.'

Fortunately these principles currently inform British-China relations - to the benefit of both countries.