Penn China Center’s sixth annual conference, scheduled for April 26-27, 2018 will have as its theme “Reform and Opening: 40 years and Counting.” The conference will address China’s 40 years of reform and opening to the outside through examining the domestic economy, rural reform, SOEs and private enterprises, financial sector reform, trade and currency issues, as well as outbound and inbound foreign investment.
The discussion I’ll be launching will be based on my paper, The Renminbi and Systemic Risk, but with a trade twist. Specifically, the Trump administration has pushed vigorously for the liberalization of a number of sensitive sectors in the Mainland. China has, for one, proposed opening its financial services sector, a proposal US authorities have largely greeted. However, in a world where China’s economic growth is slower, and where China’s financial markets are already adopting to the liberalization of the country’s currency, the very concept of financial services liberalization implies different kinds of tradeoffs than might have been the case in the past.
Specifically, as I show in my paper, China’s financial markets are highly opaque, and in some important regards, poorly supervised and regulated. The RMB system by which China has opened its capital account can be described as a Swiss cheese patchwork of varying capital account schemes. Furthermore, the operationalization of monetary and macroprudential rules is often ad hoc and informal, leading to little predictability. Growth has tended to take precedence over investor protection. As a result, liberalization could lead, in effect, to more problematic assets landing on the balance sheets of US investors, whose risks would, in a world of low Chinese GDP growth, potentially outweigh their upside potential.
Second, US participation in China’s financial markets would seem to portend new kinds of feedback loops that could ironically increase, not decrease, the exposure of U.S. firms to changes in U.S. monetary policy. The conventional story, simply put, is that financial globalization can assist in portfolio diversification. However, given China’s sluggish growth, the results could be the opposite. If another country, and especially the United States, was to ever run into a high inflationary cycle, and raise its interest rates, it would draw capital from China given the liberalization of capital controls. This in turn could slow the Chinese economy, putting fragile and poorly supervised non-banks under even more pressure. If they were to collapse, US firms participating in China could find themselves unduly exposed.
Together, these observations would suggest that while increased access to China’s financial services industry may sound good in principle, any such liberalization should be brought within a larger package of legally-binding financial regulatory reform commitments. The negotiation of China’s financial market liberalization is not, in short, an exercise that can be taken in isolation of negotiations tied to reforms.