Russia: Money, Banking, and Financial Markets

China’s Economy: International and Monetary Sectors, PART TWO George C Georgiou PhD Professor of Economics February 22-23, 2012

SESSION EIGHT

• CHINA’S CENTRAL BANKING SYSTEM: • PEOPLE’S BANK OF CHINA (PBC)

PEOPLE’S BANK OF CHINA (PBC): The Early Years • Established on December 1, 1948 based on the consolidation of the Huabei Bank, the Beihai Bank and the Xibei Farmer Bank. • In September 1983, the State Council decided to have the PBC function as a central bank. • The Law of the People's Republic of China on the People's Bank of China adopted on March 18, 1995 by the 3rd Plenum of the 8th National People's Congress has since legally confirmed the PBC's central bank status.

PBC: Major Responsibilities • People's Bank of China Law of December 27, 2003, provides that the under the guidance of the State Council, the PBC shall – formulate and implement monetary policy, – prevent and resolve financial risks, and – safeguard financial stability.

PBC: Major Functions • Issuing and enforcing relevant orders and regulations; • Formulating and implementing monetary policy; • Issuing Renminbi (Yuan) and administering its circulation; • Regulating inter-bank lending market and interbank bond market; • Administering foreign exchange and regulating inter-bank foreign exchange market;

PBC: Major Functions cont. • Regulating gold market; • Holding and managing official foreign exchange and gold reserves; • Managing the State treasury; • Maintaining normal operation of the payment and settlement system; • Guiding and organizing the anti-money laundering work of the financial sector and monitoring relevant fund flows;

PBC: Major Functions cont. • Conducting financial statistics, surveys, analysis and forecasts; • Participating in international financial activities in the capacity of the central bank; • Performing other functions specified by the State Council.

Monetary Policy • The objective of the monetary policy is to maintain the stability of the value of the currency and thereby promote economic growth.

Monetary Policy Instruments • Reserve requirement ratio, • Central bank base interest rate, (US Fed. Funds Rate) • Central bank lending, (US Discount Rate) • Open market operation and other policy instruments specified by the State Council.

Monetary Policy Committee (US FOMC) • Consultative body for the making of monetary policy by the PBC, • Responsibility is to advise on the – formulation and adjustment of monetary policy and policy targets, – application of monetary policy instrument, – major monetary policy measures, and the – coordination between monetary policy and other macroeconomic policies.

Monetary Policy Committee cont. • The Committee plays its advisory role on the basis of comprehensive research on macroeconomic situations and the macro targets set by the government.

Modern Central Bank Objectives: Summary

The Functions of a Modern Central Bank

PBC: Independence(?) • Under the leadership of the State Council, the PBC implements monetary policy, performs its functions and carry out business operations independently according to laws and free from intervention by local governments, government departments at various levels, public organizations or any individuals.

PBC: Independence (cont.) • The PBC needs to report to the State Council its decisions concerning the annual money supply, interest rates, exchange rates and other important issues specified by the State Council for approval before they are put into effect.

PBC: Independence (cont.) • The PBC is also obliged to submit work reports to the Standing Committee of the National People's Congress on the conduct of monetary policy and the performance of the financial industry. • All capital of the PBC is invested and owned by the State.

PBC: Management • The top management of the PBC is composed of the governor and a certain number of deputy governors. • The governor of the PBC is appointed into or removed from office by the President of the People's Republic of China. The candidate for the governor of the PBC is nominated by the Premier of the State Council and approved by the National People's Congress.

SESSION NINE

• CHINA’S FOREIGN EXCHANGE RATE • FOREIGN EXCHANGE MARKET • And EXCHANGE RATE POLICY

In this session: • • • • •

Introduction Functions of the Foreign Exchange Markets Foreign Exchange Rates Flexible versus Fixed Exchange Rates Eurocurrency or Offshore Financial Markets

Salvatore: International Economics, 10th Edition ©

FOREIGN EXCHANGE MARKET • Foreign Exchange Market – Where individuals, firms and banks buy and sell foreign currencies or foreign exchange.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Functions of the Foreign Exchange Markets 1. Transfer purchasing power from one nation and

currency to another.  Demand for currency arises when:   

Tourists visit another country Domestic firm wants to import from other countries Individual wants to invest abroad

 Supply of currency arises from:  



Foreign tourist expenditures Export earnings Receiving foreign investments


Functions of the Foreign Exchange Markets 2. Provide credit for foreign transactions  Credit is needed when goods are in transit, and to allow the buyer time to

resell the goods to make the payment.

3. Provide the facilities for hedging and speculation.  About 90% of foreign exchange trading reflects purely financial

transactions, and only about 10% trade financing.


Functions of the Foreign Exchange Markets

• Participants – Those needing currency to fund transactions • Tourists, importers, exporters, investors, etc.

– Commercial banks • Serve as the clearinghouses for currency exchange

– Foreign exchange brokers • Clearinghouse for surpluses and shortages between the commercial banks

– Central banks • Buyer or seller of last resort in the foreign exchange market


FOREIGN EXCHANGE RATES • Assume only two economies, the United States and China. – Domestic currency = dollar ($) – Foreign currency = Renminbi or Yuan (RMB)

• The exchange rate between the dollar ($) and the yuan (RMB) is equal to the number of dollars needed to purchase one RMB. XR

= $/RMB

If XR = $/RMB= 0.16, then $0.16 dollars (16.0 Cents) is required to purchase one RMB. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Foreign Exchange Rates • The XR can also be stated in terms of the foreign currency per unit of the domestic currency • XR = RMB/$ = RMB 6.3/$1

Foreign Exchange Rates • Under a flexible exchange system, XR is determined by the intersection of market demand and supply curves for rubles. • Depreciation is an increase in the domestic price of the foreign currency. – If the dollar price of the RMB increases from $O.16 to $0.20, the dollar has depreciated (RMB has appreciated).

• Appreciation refers to a decline in the domestic price of the foreign currency. – If the dollar price of the RMB decreases from $0.16 to $0.12, the dollar has appreciated (RMB has depreciated).


FIGURE 14-1 The Exchange Rate Under a Flexible Exchange Rate System. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Foreign Exchange Rates  Effective exchange rate 

A weighted average of the exchange rates between the domestic currency and the nation’s most important trading partners.


Foreign Exchange Rates  Arbitrage 

The purchase of currency in one market for immediate re-sell in another market.



Arbitrage keeps the exchange rate between any two currencies the same across different markets.



The purchase/re-selling closes differences in exchange rates by reducing currency available in the low price market and increasing availability in the high price market.


FIGURE 14-2 Disequilibrium Under a Fixed and Flexible Exchange Rate System.


• CHINA’S EXCHANGE RATE POLICY: • FLEXIBLE VERSUS FIXED EXCHANGE RATES

In this section: • The Case for Flexible Exchange Rates • The Case for Fixed Exchange Rates • Exchange Rate Bands, Adjustable Pegs, Crawling Pegs, and Managed Floating

Salvatore: International Economics, 10th Edition ©

Introduction

• Advocates of a fixed exchange rate system argue for the certainty and stability of fixed rates, while advocates of a flexible rate claim more efficiency in correcting balance of payments disequilibria. • There is no clear-cut conclusion about whether fixed or flexible exchange rates are superior. (most economists for flexible XRs) Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

The Case for Flexible Exchange Rates

• A flexible exchange rate system is said to be more efficient than a fixed exchange rate system because: 1. It relies only on changing exchange rates, not prices, to adjust balance of payments.

2. It makes adjustments smooth and continuous rather than occasional and large. 3. It clearly identifies the nation’s degree of comparative advantage and disadvantage in various commodities. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

The Case for Flexible Exchange Rates

• The policy advantages of a flexible exchange rate system: (laissez faire ideology) 1. It frees monetary policy for domestic goals. 2. It enhances the effectiveness of monetary policy. 3. It allows each nation to pursue its own inflationunemployment trade-off. 4. It removes the danger that the government will use the exchange rate to reach goals better achieved by other policies. 5. It eliminates the cost of official interventions in foreign exchange markets. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

The Case for Fixed Exchange Rates

• The case for fixed exchange rates rests on: 1. Less uncertainty than flexible rates. • Flexible rates do lead to excessive volatility in exchange rates.

2. Speculation likely to be more stabilizing than flexible rates. • Empirical evidence suggests that a flexible system does not compare unfavorably with a fixed rate system with respect to whether speculation is stabilizing or destabilizing.

3. Less inflationary than flexible rates. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

FIGURE 20-1 Shifts in the Nation’s Demand Curve for Foreign Exchange and Uncertainty.


FIGURE 20-2 Fluctuations in Exchange Rate in the Absence of Speculation and with Stabilizing and Destabilizing Speculation. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Exchange Rate Bands, Adjustable Pegs, Crawling Pegs, and Managed Floating

• Exchange Rate Bands – Most fixed exchange rate systems allow the rate to fluctuate within narrowly defined bands above and below par value. – The actual exchange rate is determined by supply and demand within the band of fluctuation, and is prevented from moving outside band by official intervention.



• Adjustable Pegs – An adjustable peg requires defining the par value and the band of fluctuation, with the stipulation that the currency will be devalued to correct balance of payments deficit, or revalued to correct surpluses.



• Crawling Pegs – Under a crawling peg system, par values are changed by small preannounced amounts or percentages at frequent and clearly specified intervals until the equilibrium exchange rate is reached. – This is done to avoid relatively large changes in par values and possibly destabilizing speculation.



• Managed Floating – Under a managed floating exchange rate system, the nation’s monetary authorities are responsible for intervening in foreign exchange markets to smooth out short-run fluctuations without attempting to affect long-run trend in exchange rates.



• Managed Floating – A policy of leaning against the wind requires the monetary authority to: • Supply (from reserves) a portion of short-run excess demand for foreign exchange, moderating tendency of currency to depreciate. • Absorb (add to reserves) a portion of any short-run excess supply, moderating tendency of currency to appreciate.

– This reduces short-run fluctuations without affecting the long-run trend in exchange rates. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

(Figure continues on next 2 slides)

FIGURE 20-3 Exchange Rate Band, Adjustable Pegs, and Crawling Pegs.


FIGURE 20-3 (continued) Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

FIGURE 20-3 (continued)


SESSION TEN • CHINA’S FOREIGN EXCHANGE RESERVES • CHINA’S HOLDINGS OF UNITED STATES DEBT

China’s Gold and Foreign Exchange Reserves Gold (Million Ounces)

FX Reserves ($billion)

1998

12.67

144.9

2000

12.67

154.8

2002

19.29

286.4

2004

19.29

609.9

2006

19.29

1,066.3

2008

19.29

1,946.0

2010

33.89

2,847.3

2011, June 30

33.89

3,197.5

United States Debt ($billions) Debt held by the Public

Total Public Debt

9/28/2001

3,339

5,807

9/30/2002

3,553

6,228

9/30/2003

3,924

6,783

9/30/2004

4,307

7,379

9/30/2005

4,601

7,932

9/29/2006

4,843

8,506

9/28/2007

5,049

9,007

9/30/2008

5,808

10,024

9/30/2009

7,551

11,909

9/30/2010

9,022

13,561

9/30/2011

10,127

14,790

2/06/2012

10,577

15,337

Major Foreign Holders of Treasury Securities, November 2011 ($billions) China

1,132.6

Japan

1,038.9

United Kingdom

429.4

Brazil

206.4

Caribbean Banking Centers (Offshore)

185.3

Taiwan

149.6

Switzerland

113.9

Hong Kong (Offshore)

105.3

Russia

89.7

Canada

88.4

Luxembourg

72.9

China’s Holdings of U.S. Debt • Over 50% of publicly held U.S. Treasury securities are held by foreigners. • The Chinese government, through its central bank, has become the single largest foreign holder of U.S. debt. • In November 2011, China and Hong Kong together held $1,238 billion of the outstanding, officially registered U.S. Treasury securities.

China’s Holdings of U.S. Debt cont. • China’s total purchase of U.S. government debt, including large-scale purchases of the bonds of U.S. government-owned Fannie Mae and Freddie Mac and unregistered purchases of Treasuries through Caribbean tax havens and through the London currency market, are estimated to be far larger, perhaps double the amount of officially registered purchases.

China’s Holdings of U.S. Debt cont. • The growing U.S. debt held by foreign governments, particularly that of China, has raised the fear that if foreigners suddenly decided to stop holding U.S. Treasury securities or decided to diversify their holdings, the dollar could plummet in value and interest rates would rise.

China’s Holdings of U.S. Debt cont. • China’s growing influence: – Others are concerned that China’s accumulation of hard currency assets will allow it to undertake activities in the foreign affairs and military realms that are not in the U.S. interest.

China’s Holdings of U.S. Debt cont. • Reality Check • In fact, China is unlikely to choose to sell its dollar holdings. • There are no adequate substitutes in the international currency markets for the dollar, which is the world’s dominant reserve currency. (for the foreseeable future!)

China’s Holdings of U.S. Debt cont. • If China were to decide to sell its Treasury securities, China would lose billions of dollars and also have to abandon the very system that supports its export-led economy.

China’s Treasury Purchases are Strategic • China’s willingness to reinvest its export earnings primarily in low-interest-bearing U.S. Treasury securities has helped create the misperception that China intends to loan money to the U.S. as – a favor, or – to gain influence in Washington.

China’s Treasury Purchases are Strategic cont. • In fact, the government of China purchases U.S. Treasuries as a safe investment vehicle for its accumulated dollars and as part of its strict capital controls designed to maintain an artificial, government-set exchange rate between the renminbi (RMB) and the dollar.

China’s Treasury Purchases are Strategic cont. • By Chinese law, all dollar earnings for its exports are exchanged at China’s state-owned banks for local currency. (“sterilization”) • The dollars are then used to buy U.S. dollardenominated debt, principally U.S. Treasuries. • China’s investment and export-led growth strategy depends on an undervalued RMB, which makes Chinese exports cheaper and attracts foreign investment.

China’s Limited Foreign Exchange Reserves Options • Wholesale shift to the two other reserve currencies, the euro or the yen, is not feasible, because neither currency circulates sufficiently to provide a real alternative to the dollar, which constitutes over 60% of the world’s currency reserves. • The dominance of the dollar in international markets is more pronounced when measured by currency transactions: over 85% of total.

SESSION ELEVEN

• THE RENMININI’S (RMB) ROLE IN THE GLOBAL MONETARY SYSTEM • FUTURE INTERNATIONAL RESERVE CURRENCY?

U.S. benefits from the dollar’s status as the world’s preferred reserve currency • Because the U.S. government can borrow in dollars, it does not face the risk that fluctuations in currency values could cause the government to owe more principal than it borrowed. • Because foreign governments generally hold their dollar reserves in Treasury securities, this lowers the interest rate that the U.S. Government otherwise would pay to lenders.

U.S. benefits from the dollar’s status as the world’s preferred reserve currency • The U.S. government also benefits from the use of U.S. currency as a globally accepted medium of exchange, because the government can print the money and spend it without having to pay interest, a practice known as “seigniorage.”

The Renminbi’s Role in the Global Monetary System • Of the currencies of the world’s 6 largest economies • China’s Renminbi is the only one that is not a reserve currency!

The Renminbi’s Role in the Global Monetary System cont. • Internalization: its use in denominating and settling cross-border trade and financial transactions (international medium of exchange) • Capital account convertibility: level of restrictions on inflows and outflows of financial capital. • Reserve currency: whether the renminbi is held by foreign central banks as protection against balance of payments crises

China’s Capital Account • Has become more open as controls on both inflows and outflows have been relaxed. • China is promoting the international use of its currency by: – Permitting the settlement of trade transactions with the renminbi – Easing restrictions on cross-border remittances of the renminbi for settlement

China’s Capital Account cont. – Allowing the issuance of renminbi-denominated bonds in Hong Kong and by foreigners in the Mainland – Permitting selected banks to offer offshore renminbi deposit accounts – Setting up local currency bilateral swap lines with other central banks These steps are gaining traction, although still modest in scale. A big advantage is Hong Kong!

Renminbi’s Prospects as a Reserve Currency • Economic size: A country’s size and its shares of global trade and finance are important – China has 10% of world GDP – China has 9% of world trade – In 2011 China accounted for 25% of world GDP growth

Renminbi’s Prospects as a Reserve Currency cont. • Open capital account: The currency must be easily tradable in global financial markets with no restrictions on capital flows. – China is gradually and selectively easing restrictions on both inflows and outflows. – But there are still extensive capital controls.

Renminbi’s Prospects as a Reserve Currency cont. • Flexible exchange rate: Reserve currencies generally trade freely, and there external value is market determined. – China still has tightly managed exchange rate – This will become increasingly hard to manage as the capital account becomes more open.

Renminbi’s Prospects as a Reserve Currency cont. • Financial Market Development: A country must have broad, deep and liquid financial markets so that international investors will have access to a wide array of financial assets denominated in its currency. – China has relatively shallow and underdeveloped government and corporate bond markets

Renminbi’s Prospects as a Reserve Currency cont. • Macroeconomic policies: Investors in a country’s sovereign assets must have faith in its commitment to low inflation and sustainable levels of public debt. – China has a lower ratio of explicit public debt to GDP than most major reserve currency economies – China has maintained moderate inflation in recent years.

In Addressing these criteria vis-à-vis the renminibi • China faces two major challenges: – Sequencing of capital account opening with other policies, such as exchange rate flexibility and financial market development, to improve the cost/benefit payoff – Financial market development: strengthening the banking system; developing deep and liquid government and corporate bond markets, as well as foreign exchange spot and derivative markets.

Summary Assessment • China’s ability to meet these challenges will determine the balance and sustainability of its economic development as well as the renminbi’s role in the global monetary system.

Forecasting the renminbi’s future • China is adopting its own unique approach: Capital Account liberalization with “Chinese characteristics” • The following outcomes are anticipated: – Government’s medium objective is an open capital account but with numerous “soft” controls. (doable within the next 5 years) – This will allow the currency to play an increasingly significant role in global trade and finance, but in a manner that allows the government to retain some control over capital flows.

Forecasting the renminbi’s future cont. • The renminbi will be included in the basket of currencies that make up the IMFs Special Drawing Rights basket (doable within the next 5 years) • Low level of financial market development: Although China’s rapid growth will help promote the international use of its currency, this is a major constraint on the renminbi attaining reserve currency status

CONLUSION ON THE RENMINBI • The Renminbi will become a reserve currency within the next decade, eroding but not displacing the dollar’s dominance.

SESSION TWELVE

CHINA’S OUTWARD FOREIGN DIRECT INVESTMENT (FDI)

China’s Outward FDI Flows & Stock, 2010 (Billions of $) Flows Total Financial FDI NonFinancial

Stock

Sum

Change (%)

Share (%)

Sum

Share (%)

68.81

21.7

100.0

317.21

100.0

12.5

55.25

17.4

87.5

261.96

82.6

8.63 60.18

1.1 (-) 25.9

Outward FDI Flows of Major Home Economies, 2010 ($b) USA

328.9

Germany

104.86

France

84.11

Hong Kong

76.01

China

68.81

Japan

56.26

Russia

51.70

Canada

38.58

Netherlands

31.90

Korea

19.23

India

14.63

Outward FDI Stock of Major Home Economies, 2010 ($b) USA

4843.3

UK

1689.3

France

1523.0

Germany

1421.3

Japan

831.1

Russia

433.6

Sweden

336.1

China

317.2

Singapore

300.0

Brazil

180.9

India

92.4

China’s Outward FDI flows and stock ($b) Year

Flows

Stock

2002

2.7

19.9

2003

2.85

33.2

2004

5.5

44.8

2005

12.26

57.2

2006

21.16

90.63

2007

26.51

117.91

2008

55.91

183.97

2009

56.53

245.75

2010

68.81

317.21

Key Drivers of China’s OFDI • Need to secure natural resources • Export industries need services like shipping & insurance • Major enterprises are acquiring global brands • Large state-owned enterprises (SOEs) are diversifying internationally • Some enterprises seek to move their laborintensive operations to cheaper overseas locations like Vietnam & Africa

China’s Outward FDI Flows by region, 2004-2010 ($b) Region

2004

2005

2006

2007

2008

2009

2010

TOTAL

5.49

12.26

17.63

26.50

55.90

56.52

68.81

Asia

3.01

4.48

7.66

16.59

43.54

40.40

44.89

Africa

0.31

0.39

0.51

1.57

5.49

1.43

2.11

Europe

2.04

2.16

0.59

1.54

0.87

3.35

6.76

Lat. Am.

1.76

6.46

8.46

4.90

3.67

7.32

10.53

N. Amer. 0.12

0.32

0.25

1.12

0.36

1.52

2.62

Oceania

0.20

0.12

0.77

1.95

2.47

1.88

0.12

China’s Outward FDI Stock by region, 2004-2010 ($b) Region

2004

2005

2006

2007

2008

2009

2010

TOTAL

44.77

57.20

75.02

117.91

183.97

245.75

317.21

Asia

33.47

40.95

47.97

79.21

131.31

185.54

228.14

Africa

0.89

1.59

2.55

4.46

7.80

9.33

13.04

Europe

0.67

1.27

4.45

0.01

5.13

8.67

15.71

Lat. Am.

8.26

11.46

19.69

24.70

32.24

30.59

43.87

N. Amer.

0.90

1.23

1.58

3.24

3.65

5.18

7.82

Oceania

0.54

0.65

0.93

1.83

3.81

6.41

8.60

China’s Outward FDI Stock by region, 2010 ($b) (%of Total) Region

$ billions

Percentage %

TOTAL

317.21

100.0

Asia

228.14

71.9

Africa

13.04

4.1

Europe

15.71

5.0

Latin America

43.87

13.8

North America

7.82

2.5

Oceania

8.60

2.7

China’s Outward FDI Stock by region, 2004-2010 ($b) (% of Total) cont. • These figures are distorted by the use of tax havens, which obscure actual destinations. • For example in Asia: – Hong Kong

$199.1b

63%

• For example in Latin America: – British Virgin Islands – Cayman Islands

$23.3b 17.3b

7.3% 5.5%

China’s Outward FDI Trends • As China’s growth path continues at historical breath-taking pace: – China’s resource needs will continue to increase – China will continue to seek secure reliable supplies by doing deals with producers

China’s Outward FDI Trends cont. • With $3.2 trillion (January 2012) in foreignexchange reserves: – China can afford large investments overseas – China’s MNCs can snap up companies on the cheap • Acquire market share • Acquire global brands

China’s Outward FDI • • • •

Role of State-Owned Enterprises (SOEs) Crucial Issue: Corporate Governance Most of China’s FDI is by SOEs Crucial element in assessing Chin’s FDI on receiving nations’ national interest • Independence of SOEs remains a problem • Less of a problem for private firms

China’s Outward FDI • Some countries welcome Chinese investment – E.g., African countries, happy top receive accompanying unconditional aid

• However, as China becomes more powerful, politically & economically, and expands its business globally, more & more governments have Chinese investment on their radar.

China’s Outward FDI • Widespread suspicions of China’s intentions • Predominance of SOEs in China’s OFDI • Raised fears that such investment may not be governed by normal commercial considerations, and • May even be an arm of the country’s foreign and defense policy

Top 10 non-financial Chinese TNCs ranked by outward FDI stock, 2010 • • • • • • • • •

1. China Petrochemical Corporation (SOE) 2. China National Petroleum Corporation (SOE) 3. China National Offshore Oil Corporation (SOE) 5. China Resources (Holdings) Co., Ltd. (SOE) 6. China National Cereals, Oils & Foods (SOE) 7. Aluminum Corporation of China (SOE) 8. China Merchants Group (SOE) 9. Sinochem Corporation (SOE) 10. China Unicom Corporation (SOE)

Top 10 non-financial Chinese TNCs ranked by foreign assets, 2010 • • • • • • • • • •

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

China Unicom Corporation (SOE) China National Petroleum Corporation (SOE) China Petrochemical Corporation (SOE) China Resources (Holdings) Co., Ltd. (SOE) China National Offshore Oil Corporation (SOE) China Merchants Group (SOE) China State Construction Engineering Corporation China Ocean Shipping (Group) Company (SOE) Sinochem Corporation (SOE) China Mobile Communications Corporation (SOE)

Top 10 non-financial Chinese TNCs ranked by foreign revenues, 2010 • • • • • • • • • •

1. 2. 3. 4. 5. 6. 7. 8. 9 10.

China Petrochemical Corporation (SOE) China National Petroleum Corporation (SOE) Sinochem Corporation (SOE) China National Offshore Oil Corporation (SOE) China Resources (Holdings) Co., Ltd. (SOE) China Unicom Corporation (SOE) Huawei Technologies Co., Ltd. Legend Holdings Ltd. China Ocean Shipping (Group) Company (SOE) China National Cereals, Oils & Foods (SOE)

SESSION THIRTEEN • CHINA’S OFFSHORE BANKING

OFFSHORE BANKING • A bank located outside the country of residence of the depositor, • typically a low tax jurisdiction (or tax haven) that • provides financial and legal advantages

Advantages of an Offshore bank • Greater privacy (bank secrecy) • Low or no taxation (i.e., tax havens) • Easy access to deposits (at least in terms of regulation) • Protection against local political or financial instability

Offshore Banking: Background • Often associated with: – Underground economy and – Organized crime, via – Tax evasion and – Money laundering

CHINA’S OFFSHORE BANKING • By definition, an offshore bank account is an account with a bank located out of the country of residence. • More specifically, it refers to bank accounts held within tax heavens or offshore jurisdictions. • Authority overseeing China’s Offshore Banking: – People’s Bank of China (PBC) – State Administration of Foreign Exchange of China (SAFE)

CHINA’S OFFSHORE BANKING • Offshore Banking centers favored by Chinese include: – Hong Kong – Singapore – Labuan, Malaysia – British Virgin Islands – Cayman Islands – Macao – Taiwan

CHINA’S OFFSHORE BANKING • Recent development: • Selected banks in mainland China have obtained the necessary licenses to develop offshore banking services, including: – – – – – – –

Shenzhen Development Bank (SOE) Guangdong Development Bank, China Merchants Bank Industrial and Commercial Bank of China (SOE) Agricultural Bank of China (SOE) Shanghai Pudong Development Bank China Construction Bank (SOE)

CHINA’S OFFSHORE BANKING • Growing role of China’s Entrepreneurs • Growing collaboration between Beijing and private entrepreneurs in the global financial system • Aim is to assist Beijing to diversify the nation’s massive foreign-exchange reserves • Assist Beijing to diversity the nation’s growing FDI • Beijing is presenting this as its delivering on its commitment to the WTO to gradually deregulate the banking sector to foreign participation!!

CHINA’S OFFSHORE BANKING • Salient Features: – – – – –

Preferential tax policy (Tax Heavens) Relaxed policy regulation Convenient global fund-raising Stable capital returns Complete privacy (Bank Secrecy)?

• Main offshore-banking clients are state-owned enterprises and entrepreneurs involved in crossborder trading

CHINA’S OFFSHORE BANKING • State Administration of Foreign Exchange of China (SAFE) has acknowledged that “the lack of regulations in off-shore banking can make it easy for illegal activities and could become the channel for illegal capital flow” • A lot of Non-Resident Accounts (NRAs) are companies set up by Chinese citizens in Hong Kong and many of them deal with cross-border trading. • This arrangement can help them effectively bypass complicated settlement process and conduct swift transactions with customers in overseas accounts.

CHINA’S OFFSHORE BANKING • ("SWIFT") The Society for Worldwide Interbank Financial Telecommunication operates a worldwide financial messaging network which exchanges messages between banks and other financial institutions.

Terrorist Finance Tracking Program • The US following September 11, 2001, had a program to access the SWIFT database, rendering offshore banking for privacy severely compromised.

CHINA’S OFFSHORE BANKING • Recent figures indicate that China currently has more than 500,000 high net worth individuals (HNWIs) with a • Combined wealth of over $2.5 trillion • Offshore investments currently account for only 10% of Chinese HNWIs – By comparison it is 20% in U.S. – By comparison it is 30% in Europe

CHINA’S OFFSHORE BANKING • At present Hong Kong is the major destination for Chinese HNWIs’ offshore investments. • Hong Kong serves as a gateway for mainland capital flowing into foreign markets. • Furthermore, many mainland enterprises have business dealings with Hong Kong and often park capital there

CHINA’S OFFSHORE BANKING • Increasing competition between overseas branches of mainland China banks and foreign banks for Chinese offshore banking funds. • Increasing surveillance and oversight by the foreign-exchange watchdog has followed. • Regulators are tracking more closely NRAs • Checking frequently transactions between offshore and onshore accounts

SESSION FOURTEEN • CHINA’S ANTI-MONEY LAUNDERING AND COMBATING THE FINANCING OF TERRORISM (AML/CFT)

Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT • How to ensure Chinese financial institutions are not used by: – Money launderers – Financial criminals, or – Financiers of terrorism

Anti-Money Laundering and Combating the Financing of Terrorism • Anti-Money Laundering Bureau (Security Bureau): – Responsible for anti-money laundering activities in the People's Republic of China; – conducting studies on and establishing antimoney laundering rules and policies for financial institutions; – engaging in international cooperation on antimoney laundering;

Anti-Money Laundering Bureau cont. • consolidating and analyzing information on suspicious payment transactions in RMB or foreign currencies provided by various sources; • assisting the judiciary departments in the investigation into money-laundering related criminal cases; • ensuring proper security arrangement for the PBC system; • and organizing armed protection for the storage and transportation of gold, silver, bank notes and securities.

Anti-Money Laundering Bureau cont. • Recent efforts include: – Establishing the mechanism of freezing terrorismrelated assets in the financial sector and improving the quality of Suspicious Transaction Reports (STRs) – Improved the AML/CFT supervision and strengthening AML/CFT investigations

What is Money Laundering? • Conversion of ‘dirt’ money into ‘clean’ money. • “Dirty’ money is money that: – (1) has been derived by illegal means, and – (2) it is possible to identify that condition (1) applies

How do you launder money? • The process consists of three phases: – Placement: the money enters the financial system (convert the cash into ‘book’ money) – Layering: cover the tracks (delete the past, the “illegitimate origins”) – Integration: find a way to spend it (avoid suspicions)

Why launder dirty money at all? • Two motives: – Avoiding suspicion (need to remove all traces that my indicate a crime was committed “dirty money”) – Avoiding detection (need to shield the money from attempts to confiscate it)

Why fight money laundering? • Because no one should be able to enjoy the fruits of crime. • However, there are costs to fighting crime. • Support for anti-money laundering activities exists if the benefits of doing so exceed the costs: controversial/political issue

Why fight money laundering? Cont. • World without money laundering would be a world with less crime. Why? • First, most crime is committed to obtain an (illegal) profit. Difficult to enjoy these profits without money laundering. Incentive for committing crimes of that sort should be reduced. • Second, money laundering allows for more sophisticated investment of criminally obtained money, thus boosting the financial resources of criminal groups.

Why fight money laundering? Cont. • Additional consequences of money laundering: – If left unchecked, criminal money will slowly infiltrate the ‘legal’ economy and in the end will threaten the integrity of the whole society. – Enormous amounts of dirty money injected into the international financial markets “hot money” may destabilize the financial system, “currency speculation.”

How much money is being laundered? • IMF estimates that that each year $500 million and $1.5 billion of “dirty” money is being laundered in the international financial markets.

What to do against money laundering? • Preventive measures: aim at denying criminals the access to the financial system and tend to rely heavily on the private sector’s cooperation. • Repressive measures: aim to facilitate prosecution or to have more effective sanctions at hand. (international legal cooperation and asset forfeiture)

CONCLUDING REMARKS • PROBLEMS FACING THE CHINESE ECONOMIC SYSTEM

FIVE PROBLEMS FACING THE CHINESE ECONOMIC SYSTEM • • • • •

Corruption Income Disparity Education Healthcare Environmental Degradation

CORRUPTION • Corruption in China is widespread and has gotten worse in the last decade. • Corruption: Government officials taking advantage of their economic power to obtain illegitimate personal gains from the public and private institutions, or government organizations.

CORRUPTION cont. • Government Officials’ economic power is derived from the economic assets under their control such as financial assets of state-owned banks or land. • Power is also derived from their authority in granting economic assets such a licenses or permits.

CORRUPTION cont. • Possible solution: – Reduce the economic power of government officials

• Political feasibility of doing this: – Nil

INCOME DISPARITY AND RURAL POVERTY • In China the income disparity between the urban rich and the rural poor has widened in the last fifteen years. • The per capita income of the urban population has been growing at an annual rate of 7.5%, while that of the rural population has been growing at 5.5%.

INCOME DISPARITY AND RURAL POVERTY cont. • Three major components to this problem: – The rural population has experienced a widening income gap in comparison with the urban rich. – The unfavorable treatment of the rural residents by the central government as compared with the urban residents – The mistreatment of the rural population by village Communist Party secretaries who have power to control the population in the villages.

EDUCATION • Two aspects of the problem of income disparity are: – Inadequate education, and – Inadequate healthcare, that the poor residents in rural areas receive.

EDUCATION cont. • Although China has an official policy of providing compulsory education of nine years, • in reality many children of school age do not receive nine years of education because • the central government does not financially support this policy and • leaves the financial responsibility to the local governments.

EDUCATION cont. • The inequality of education opportunities between the rich and the poor affects • Income inequality for future generations, and also • Hinders the selection of the most able young people in China for personal development.

EDUCATION cont. • Although in the last few years the central government has increased its subsidy to local governments for education, • inequality of education opportunities still persist and the children of very poor families do not get educated.

HEALTHCARE • Like education, health care is the responsibility of the government but the central government does not finance most of it and leaves its financing to local governments; • The central government has devoted more resources to the urban population in healthcare than the rural population.

HEALTHCARE cont. • In rural China before economic reform, health care provision was good given its low level of income. • After economic reform, with the introduction of private farming and the disintegration of the communes, financing and provision of healthcare have been left to market forces. • The rural population in some poor areas cannot afford to pay for medical care, often do not go to get treatment when they get sick.

HEALTHCARE cont. • Healthcare for the urban population has been better since economic reform. • However, healthcare remains a major problem in China because the price has been rising at the rate of about 12% per year in the last ten years and quality of service has deteriorated with long waiting lines in good hospitals.

HEALTHCARE cont. • The reason for the rapid rise in the price of medical care is the the quantity supplied per person has remained constant since 1995, but the demand for healthcare has increased rapidly because of the increase in per capita real income. • The reason for supply per capita to have been constant is the policy of public supply of healthcare under which the local governments are given the responsibility to provide healthcare.

HEALTHCARE cont. • Local governments do not have sufficient funds to provide healthcare in line with the growth of the local economy. • Local governments would rather use available funds for economic development. • One solution would be to allow or even encourage the entry of private hospitals. • However, unlike education, the Beijing believes healthcare is a public good.

Energy and Environment • The problem of environmental degradation is common to all developing countries that try to improve output and consumption because • both require the use of energy and • energy affects the environment.

Energy and Environment cont. • The effects of energy use include: – Air pollution – Water pollution, and the – Emission of CO2 that causes global warming

• Furthermore, the use of energy from exhaustible resources can create energy shortage in the future.

Energy and Environment cont. • The air and water in China, especially in the urban areas, are among the most polluted in the world. • CO2 emissions result in climate changes which are affecting he world’s physical and biological systems. • By 2007 China has taken over the US as the world’s top producer of greenhouse gases.

Energy and Environment cont. • China’s environmental policies aim at cutting energy costs and reducing local pollution, rather than reducing carbon emissions, the effects of which are not felt at present. • China’s central government has been aware of the environmental problems and has made serious attempts to protect and improve China’s environmental protection provisions.

Energy and Environment cont. • The most serious problem for China’s wellintended environmental policies is the failure in implementation. • The implementation of environmental policies especially in pollution control fails mainly because local government officials often do not cooperate in law enforcement as they are interested in increasing output of their own regions.

Energy and Environment cont. • The end result is that the quality of Chin’s environment will continue to deteriorate in the near future until the country is rich enough and the government is determined enough to spend more resources fro environmental protection. • The second important problem is to achieve a multinational agreement to limit the emission of CO2

Conclusion • Although the problems outlined: – – – – –

corruption, income disparity and rural poverty, education, healthcare, and environmental protection are significant problems facing China,

• These problems will not do sufficient harm to create serious social instability that would impede further growth.

APPENDIX A • CHINA: BACKGROUND INFORMATION

A: HISTORICAL BACKGROUND • For centuries China stood as a leading civilization, outpacing the rest of the world in the arts and sciences • 19th and early 20th centuries, the country was beset by civil unrest, major famines, military defeats, and foreign occupation

20th Century • After World War II: – the Communists under MAO Zedong established an autocratic socialist system that, – while ensuring China's sovereignty, – imposed strict controls over everyday life and cost the lives of tens of millions of people

20th Century cont. • After 1978, – MAO's successor DENG Xiaoping and other leaders focused on market-oriented economic development, and – by 2000 output had quadrupled.

Early 21st Century • For much of the population: – living standards have improved dramatically, and – the room for personal choice has expanded, yet – political controls remain tight.

• China since the early 1990s: – has increased its global outreach, and – participation in international organizations.

B. GEOGRAPHY • Location: Eastern Asia, bordering the East China Sea, Korea Bay, Yellow Sea, and South China Sea, between North Korea and Vietnam

• Area: 9,596,961 sq km (4th largest country in the world) • (slightly smaller than the US)

GEOGRAPHY cont. • Border countries: – Afghanistan 76 km, Bhutan 470 km, – Burma 2,185 km, India 3,380 km, – Kazakhstan 1,533 km, North Korea 1,416 km, – Kyrgyzstan 858 km, Laos 423 km, – Mongolia 4,677 km, Nepal 1,236 km, – Pakistan 523 km, Russia (northeast) 3,605 km, – Russia (northwest) 40 km, Tajikistan 414 km, – Vietnam 1,281 km

GEOGRAPHY cont. • Coastline: – 14,500 Km

• Maritime Claims: – Territorial sea: 12 nm – Contiguous zone: 24 nm – Exclusive Economic Zone (EEZ): 200 nm – Continental Shelf: 200 nm or to the edge of continental margin

GEOGRAPHY cont. • Climate – extremely diverse; tropical in south to subarctic in north

• Terrain – mostly mountains, high plateaus, deserts in west; plains, deltas, and hills in east

• Elevation Extremes – lowest point: Turpan Pendi -154 m – highest point: Mount Everest 8,850 m

GEOGRAPHY cont. • Natural Resources – coal, iron ore, petroleum, natural gas, mercury, tin, tungsten, antimony, manganese, molybdenum, vanadium, magnetite, aluminum, lead, zinc, rare earth elements, uranium, hydropower potential (world's largest)

GEOGRAPHY cont. • Arable Land: 14.86% • Natural Hazards: – frequent typhoons (about five per year along southern and eastern coasts); damaging floods; tsunamis; earthquakes; droughts; land subsidence – volcanism: China contains some historically active volcanoes including Changbaishan (also known as Baitoushan, Baegdu, or P'aektu-san), Hainan Dao, and Kunlun although most have been relatively inactive in recent centuries

GEOGRAPHY cont. • Environment – Current Issues: – air pollution (greenhouse gases, sulfur dioxide particulates) from reliance on coal produces acid rain; water shortages, particularly in the north; water pollution from untreated wastes; deforestation; estimated loss of one-fifth of agricultural land since 1949 to soil erosion and economic development; desertification; trade in endangered species

GEOGRAPHY cont. • Environment – International Agreements: – Party to: Antarctic-Environmental Protocol, Antarctic Treaty, Biodiversity, Climate Change, Climate Change-Kyoto Protocol, Desertification, Endangered Species, Environmental Modification, Hazardous Wastes, Law of the Sea, Marine Dumping, Ozone Layer Protection, Ship Pollution, Tropical Timber 83, Tropical Timber 94, Wetlands, and Whaling

C. PEOPLE • Population: – 1,336,718,015 (July 2011 est.) – 1st in the world

• Population Growth Rate: – 0.493% (2011 est.) – country comparison to the world: 151

• Net Migration Rate: – -0.33 migrant(s)/1,000 population (2011 est.) – country comparison to the world: 130

PEOPLE cont. • Death Rate: – 7.03 deaths/1,000 population (July 2011 est.) – country comparison to the world: 131

• Age Structure: – 0-14 years: 17.6% (male 126,634,384/female 108,463,142) – 15-64 years: 73.6% (male 505,326,577/female 477,953,883) – 65 years and over: 8.9% (male 56,823,028/female 61,517,001) (2011 est.)

PEOPLE cont. • Ethnic Groups: – Han Chinese 91.5%, – Zhuang, Manchu, Hui, Miao, Uighur, Tujia, Yi, Mongol, Tibetan, Buyi, Dong, Yao, Korean, and other nationalities 8.5% (2000 census

• Religion: – Daoist (Taoist), Buddhist, Christian 3%-4%, Muslim 1%-2% – note: officially atheist (2002 est.

PEOPLE cont • Urbanization: – urban population: 47% of total population (2010) – rate of urbanization: 2.3% annual rate of change (2010-15 est.)

• Major Cities: – – – – –

Shanghai 16.575 million; BEIJING (capital) 12.214 million; Chongqing 9.401 million; Shenzhen 9.005 million; Guangzhou 8.884 million (2009)

PEOPLE cont • Gender Ratio: – – – – –

at birth: 1.133 male(s)/female under 15 years: 1.17 male(s)/female 15-64 years: 1.06 male(s)/female 65 years and over: 0.93 male(s)/female total population: 1.06 male(s)/female (2011 est.)

• Life Expectancy at Birth: – – – –

total population: 74.68 years country comparison to the world: 95 male: 72.68 years female: 76.94 years (2011 est.)

PEOPLE cont. • Total Fertility: – 1.54 children born/woman (2011 est.) – country comparison to the world: 180

• Health Expenditures: – 4.6% of GDP (2009) – country comparison to the world: 148

PEOPLE cont. • Literacy: (age 15 and over can read and write) – total population: 92.2% – male: 96% – female: 88.5% (2008 census)

• Years in School: – total: 12 years – male: 11 years – female: 12 years (2009)

D. GOVERNMENT • Country name: People's Republic of China • Government type: Communist state • Administrative Divisions: – 23 provinces (sheng, singular and plural), – 5 autonomous regions (zizhiqu, singular and plural), and – 4 municipalities (shi, singular and plural)

Government cont. • Executive Branch: – chief of state: President HU Jintao (since 15 March 2003); Vice President XI Jinping (since 15 March 2008) – head of government: Premier WEN Jiabao (since 16 March 2003); Executive Vice Premier LI Keqiang (17 March 2008), Vice Premier HUI Liangyu (since 17 March 2003), Vice Premier ZHANG Dejiang (since 17 March 2008), and Vice Premier WANG Qishan (since 17 March 2008)

Government cont. • cabinet: – State Council appointed by National People's Congress

• elections: – president and vice president elected by National People's Congress for a five-year term (eligible for a second term); elections last held on 15-17 March 2008 (next to be held in mid-March 2013); premier nominated by president, confirmed by National People's Congress

• election results: – HU Jintao elected president by National People's Congress with a total of 2,963 votes; XI Jinping elected vice president with a total of 2,919 votes

Government cont. • Legislative Branch: – unicameral National People's Congress or Quanguo Renmin Daibiao Dahui (2,987 seats; members elected by municipal, regional, and provincial people's congresses, and People's Liberation Army to serve five-year terms) – elections: last held in December 2007-February 2008 (date of next election to be held in late 2012 to early 2013) – election results: percent of vote - NA; seats - 2,987 – note: only members of the CCP, its eight allied parties, and sympathetic independent candidates are elected

GOVERNMENT cont. • Judicial Branch: – Supreme People's Court (judges appointed by the National People's Congress); Local People's Courts (comprise higher, intermediate, and basic courts); Special People's Courts (primarily military, maritime, railway transportation, and forestry courts)

• Political Parties: – Chinese Communist Party or CCP [HU Jintao]; eight registered small parties controlled by CCP

E. COMMUNICATIONS • Telephones: main lines in use – 294.383 million (2010) – country comparison to the world: 1

• Telephones: mobile cellular – 859 million (2010) – country comparison to the world: 1

• Internet uses: • 389 million (2009) • country comparison to the world: 1

F. TRANSPORTATION • Airports: – 502 (2010) – country comparison to the world: 15

• Railways: – total: 86,000 km – country comparison to the world: 3

• Roadways: – total: 3,860,800 km – country comparison to the world: 2

TRANSPORTATION cont. • Waterways: – 110,000 km (navigable waterways) (2010) – country comparison to the world: 1

• Merchant Marine: – total: 2,010 vessels – country comparison to the world: 3

• Ports and Terminals: – Dalian, Guangzhou, Ningbo, Qingdao, Qinhuangdao, Shanghai, Shenzhen, Tianjin

G. MILITARY • Military Branches: – People's Liberation Army (PLA): Ground Forces, Navy (includes marines and naval aviation), Air Force (Zhongguo Renmin Jiefangjun Kongjun, PLAAF; includes Airborne Forces), and Second Artillery Corps (strategic missile force); – People's Armed Police (PAP); – PLA Reserve Force (2010)

MILITARY cont. • Military Expenditures: – 4.3% of GDP (2006) – country comparison to the world: 22

APPENDIX B • CHINA’S TRANSANTIONAL ISSUES

TRANSNATIONAL ISSUES • China – Taiwan Dispute: – Both the People's Republic of China and the Republic of China (Taiwan) officially claim to be the legitimate government of "China", including Taiwan and nearby islands currently controlled by the Republic of China. – The Republic of China (Taiwan) does not actively pursue its claims on the mainland.

TRANSNATIONAL ISSUES cont. • China – Tibet Dispute: – The Tibetan sovereignty issue refers to two political debates. – The first is whether the various territories within the People's Republic of China that are claimed as political Tibet should separate and become a new sovereign state. – The second debate, about whether Tibet was independent or subordinate to China in certain parts of its recent history.

TRANSNATIONAL ISSUES • International Disputes: (Territorial) – KASHMIR: continuing talks and confidencebuilding measures work toward reducing tensions over Kashmir that nonetheless remains militarized with portions under the de facto administration of China (Aksai Chin), India (Jammu and Kashmir), and Pakistan (Azad Kashmir and Northern Areas); India does not recognize Pakistan's ceding historic Kashmir lands to China in 1964

TRANSNATIONAL ISSUES cont. • CHINA- INDIA Dispute: (Territorial) – China and India continue their security and foreign policy dialogue started in 2005 related to the dispute over most of their rugged, militarized boundary, regional nuclear proliferation, and other matters; China claims most of India's Arunachal Pradesh to the base of the Himalayas

TRANSNATIONAL ISSUES cont. • CHINA – BHUTAN Dispute: (Territorial) – lacking any treaty describing the boundary, Bhutan and China continue negotiations to establish a common boundary alignment to resolve territorial disputes arising from substantial cartographic discrepancies, the largest of which lie in Bhutan's northwest and along the Chumbi salient

TRANSNATIONAL ISSUES cont. • CHINA – BURMA Dispute: (Territorial) – Burmese forces attempting to dig in to the largely autonomous Shan State to rout local militias tied to the drug trade, prompts local residents to periodically flee into neighboring Yunnan Province in China

TRANSNATIONAL ISSUES cont. • SOUTH CHINA SEA (EEZ) Dispute: (Territorial) – Chinese maps show an international boundary symbol off the coasts of the littoral states of the South China Seas, where China has interrupted Vietnamese hydrocarbon exploration; – China asserts sovereignty over Scarborough Reef along with the Philippines and Taiwan, and – over the Spratly Islands together with Malaysia, the Philippines, Taiwan, Vietnam, and Brunei

TRANSNATIONAL ISSUES cont. • SPRATLY ISLANDS Dispute: – the 2002 "Declaration on the Conduct of Parties in the South China Sea" eased tensions in the Spratly's but is not the legally binding "code of conduct" sought by some parties; – Vietnam and China continue to expand construction of facilities in the Spratly's, and – in March 2005, the national oil companies of China, the Philippines, and Vietnam signed a joint accord on marine seismic activities in the Spratly Islands

TRANSNATIONAL ISSUES cont. • China occupies some of the Paracel Islands also claimed by Vietnam and Taiwan; • China and Taiwan continue to reject both Japan's claims to the uninhabited islands of Senkaku-shoto (Diaoyu Tai) and Japan's unilaterally declared equidistance line (EEZ) in the East China Sea, the site of intensive hydrocarbon exploration and exploitation

TRANSNATIONAL ISSUES cont. • CHINA – NORTH KOREA Disputes: – certain islands in the Yalu and Tumen rivers are in dispute with North Korea; – North Korea and China seek to stem illegal migration to China by North Koreans, fleeing privations and oppression, by building a fence along portions of the border and imprisoning North Koreans deported by China

TRANSNATIONAL ISSUES cont. • CHINA – BURMA Dispute: – citing environmental, cultural, and social concerns, China has reconsidered construction of 13 dams on the Salween River, but energy-starved Burma, with backing from Thailand, remains intent on building five hydro-electric dams downstream despite regional and international protests

TRANSNATIONAL ISSUES cont.: Non-Territorial • ILLICIT DRUGS: – China is a major trans-shipment point for heroin produced in the Golden Triangle region of Southeast Asia. – There is a growing domestic drug abuse problem and it is a source country for chemical precursors, despite new regulations on its large chemical industry

TRANSNATIONAL ISSUES cont. • TRAFFICKING IN PERSONS: – China is a source, transit, and destination country for women, men, and children trafficked for purposes of sexual exploitation and forced labor; – the majority of trafficking in China is internal, but there is also international trafficking of Chinese citizens; – women are lured through false promises of legitimate employment into commercial sexual exploitation in Taiwan, Thailand, Malaysia, and Japan

TRANSNATIONAL ISSUES cont. • REFUGEE ASSYLUM: – Refugees by country of origin are: – 300,897 (from Vietnam), – estimated 30,000-50,000 (from North Korea)

APPENDIX C • • • •

MERCANTILIST THEORY OF TRADE CLASSICAL THEORY OF TRADE FACTOR ENDOWMENTS THEORY OF TRADE PROTECTIONISM

The Mercantilists’ Views on Trade

• Mercantilism – Economic philosophy in 17th and 18th centuries, in England, Spain, France, Portugal and the Netherlands. – Belief that nation could become rich and powerful only by exporting more than it imported.



• Mercantilism – Export surpluses brought inflow of gold and silver. – Trade policy was to encourage exports and restrict imports. – One nation gained only at the expense of another.



• Mercantilists measured wealth of a nation by stock of precious metals it possessed.

• Today, we measure wealth of a nation by its stock of human, man-made and natural resources available for producing goods and services. – The greater the stock of resources, the greater the flow of goods and services to satisfy human wants, and the higher the standard of living.


Trade Based on Absolute Advantage: Adam Smith • A nation has absolute advantage over another nation if it can produce a commodity more efficiently. • When one nation has absolute advantage in production of a commodity, but an absolute disadvantage with respect to the other nation in a second commodity, both nations can gain by specializing in their absolute advantage good and exchanging part of the output for the commodity of its absolute disadvantage.


Trade Based on Absolute Advantage: Adam Smith

• Specialization and trade advantage both countries. • Adam Smith and other classical economists advocated policy of laissez-faire, or minimal government interference with economic activity. • Free trade would cause world resources to be utilized most efficiently, maximizing world welfare. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Trade Based on Comparative Advantage: David Ricardo

• Law of Comparative Advantage – Even if one nation is less efficient than (has absolute disadvantage with respect to) the other nation in production of both commodities, there is still a basis for mutually beneficial trade.


Tariffs • Import vs. export tariffs – An import tariff is a tax or duty levied on imported commodities. • This is the most common form of tariff.

– An export tariff is a tax on exported commodities. • Prohibited by the U.S. Constitution, but occasionally practiced in developing countries to generate government revenue.

Tariffs cont. • Import vs. export tariffs • Ad valorem tariff – A fixed percentage on the value of the traded commodity.


Tariffs cont. • Import vs. export tariffs • Ad valorem tariff • Specific tariff – A fixed sum per physical unit of a traded commodity.


Tariffs cont. • • • •

Import vs. export tariffs Ad valorem tariff Specific tariff A compound tariff – A combination of an ad valorem and specific tariff.


APPENDIX D • FOREIGN EXCHANGE RATES, FOREIGN EXCHANGE MARKETS • OPTIMUM CURRENCY AREAS, CURRENCY BOARDS, AND DOLLARIZATION • OFFSHORE FINANCIAL MARKETS

APPENDIX D • In this Appendix: – Spot and Forward Rates, Currency Swaps, Futures, and Options – Foreign Exchange Risks, Hedging, and Speculation – Interest Arbitrage and the Efficiency of Foreign Exchange Markets – Optimum Currency Areas – Currency Boards Arrangements and Dollarization – Offshore Financial Markets

Spot and Forward Rates, Currency Swaps, Futures, and Options  Spot rate 

The exchange rate that calls for payment and receipt of the foreign exchange within two business days from the date when the transaction was made.

 Forward rate 

The exchange rate that calls for delivery of the foreign exchange one, three, six, twelve or twenty-four months after the date the contract is signed.


Spot and Forward Rates, Currency Swaps, Futures, and Options 

Forward discount 



The percentage per year by which the forward rate is below the spot rate.

Forward premium 

The percentage per year by which the forward rate is above the spot rate.

FD or FP = FR - SR x 4 x 100 SR


Spot and Forward Rates, Currency Swaps, Futures, and Options  Currency Swap 



A spot sale of a currency combined with a forward repurchase of the same currency – as part of a single transaction. Most interbank trading involving the purchase or sale of currencies for future delivery are done as currency swaps.


Spot and Forward Rates, Currency Swaps, Futures, and Options  Foreign Exchange Futures 



Forward currency contracts for standardized currency amounts and select dates trade on an organized market. Traded currencies:    

  

Japanese yen Canadian dollar British pound Swiss franc Australian dollar Mexican peso Euro


Spot and Forward Rates, Currency Swaps, Futures, and Options  Foreign Exchange Options (Derivatives) 

Contracts giving the purchaser the right, but not the obligation, to buy (call option) or to sell (put option) a standard amount of a traded currency on a stated date (European option) or any time before the stated date (American option) at a stated price (strike or exercise price).


Foreign Exchange Risks, Hedging, and Speculation

• Whenever a future payment must be made or received in foreign currency, a foreign exchange risk is involved because spot rates vary over time.


Foreign Exchange Risks, Hedging, and Speculation • Contracted future foreign currency payments may become more expensive if the domestic currency falls in value. – Example: • A contract requires a €100,000 payment in three months time. • If the exchange rate is currently $1/€1, the expected dollar cost is $100,000. • If the exchange rate changes to $1.10/ €1 in the intervening months, the dollar cost rises to $110,000.


Foreign Exchange Risks, Hedging, and Speculation • Contracted future foreign currency receipts may fall in value if the domestic currency increases in value. – Example: • A producer expects to receive a payment of €100,000 in three months time. • If the exchange rate is currently $1/€1, the expected dollar receipt is $100,000. • If the exchange rate changes to $0.90/ €1 in the intervening months, the dollar receipt falls to $90,000.


Foreign Exchange Risks, Hedging, and Speculation • Hedging is the avoidance of foreign exchange risk. • Options for Hedging: 1. Buy at the current spot rate and deposit the receipts in an interest earning account until the funds are needed. 2. Buy a forward contract • Typically entails paying a forward premium, increasing the cost of the transaction.

3. Buy a call option • If not exercised, the premium is lost. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Foreign Exchange Risks, Hedging, and Speculation • Speculation, the opposite of hedging, is the acceptance of foreign exchange risk in the hope of making a profit. – Example: • If the speculator expects the spot rate in three months time to be $1/€1, she may sell Euros at a current three month forward rate of $1.10/€1 with the expectation that she will be able to buy Euros to cover her sale at the lower spot rate.



• Stabilizing Speculation – The purchase of a foreign currency when the domestic price falls or is low, in the expectation that it will soon rise, leading to a profit, OR – The sale of a foreign currency when the domestic price rises, in the expectation that it will fall.

• Stabilizing speculation moderates fluctuations in exchange rates over time, serving a useful function.



• Destabilizing Speculation – The sale of a foreign currency when the domestic price falls or is low, in the expectation that it will fall even lower, OR – The purchase of a foreign currency when the domestic price rises, in the expectation that it will rise even higher.

• Destabilizing speculation magnifies fluctuations in exchange rates over time, and can be very disruptive to international flow of trade and investments.


Interest Arbitrage and the Efficiency of Foreign Exchange Markets  Interest arbitrage is the transfer of short-term

liquid funds abroad to earn a higher rate of return. 



Uncovered interest arbitrage occurs when the transfer abroad entails foreign exchange risk due to the possible depreciation of the foreign currency during the investment period. Covered interest arbitrage is the spot purchase of the foreign currency to make the investment and the offsetting simultaneous forward sale of the foreign currency to cover, or remove, the foreign exchange risk.


Interest Arbitrage and the Efficiency of Foreign Exchange Markets  Efficiency of Foreign Exchange Markets  Markets are efficient if prices reflect all possible

information.  The foreign exchange market is efficient if forward rates accurately predict future spot rates  Empirical evidence is mixed.


Optimum Currency Areas, the European Monetary System, and the European Monetary Union

 An optimum currency area is a group of nations

whose national currencies are tied by permanently fixed exchange rates.  Conditions that make optimum currency area

optimum:   

Greater mobility of resources among member nations Greater structural similarities Greater willingness of the nations to coordinate fiscal, monetary and other policies



 Benefits of optimum currency area: 

Eliminates exchange rate uncertainty, stimulating specialization in production and flow of trade and investments.



Encourages producers to view entire area as single market, benefitting from greater economies of scale.



Provides greater price stability as price shocks in different regions cancel each other out.



Saves cost of official interventions in foreign exchange markets, cost of hedging, and cost of currency exchange.



 Disadvantage of optimum currency area: 

Member nations cannot pursue independent stabilization and growth policies for their particular circumstances.


Currency Boards Arrangements and Dollarization • Under a currency board arrangement, a nation rigidly fixes the exchange rate of its currency to a foreign currency, and its central bank ceases to operate as such. • A currency board is the most extreme form of exchange rate peg short of adopting a common currency.

• Usually done when nation is in deep financial crisis, and to combat inflation.


Currency Boards Arrangements and Dollarization • Advantages: – Reduction in exchange rate risk. – Reduced domestic inflationary pressure.

• Disadvantages: – Complete loss of domestic monetary control. – No lender of last resort. – Loss of ability to earn seignorage from the creation of money.


Currency Boards Arrangements and Dollarization  Dollarization is the adoption of another nation’s

currency as legal tender.  Advantages: 

Elimination of domestic currency exchange rate risk.



External determination of inflation and interest rates.



External macroeconomic policy discipline.


Currency Boards Arrangements and Dollarization  Dollarization is the adoption of another nation’s

currency as legal tender.  Disadvantages: 

Cost of replacing domestic currency with another currency.



Loss of independence of monetary and exchange rate policies, facing same monetary policy as country whose currency was adopted.



Loss of central bank as lender of last resort.


Eurocurrency or Offshore Financial Markets • Eurocurrency refers to commercial bank deposits outside the country of their issue. – Eurodollar - A deposit denominated in U.S. dollars in a British commercial bank. – Eurosterling - A pound sterling deposit in a French commercial bank. – Eurodeposit - A deposit in Euros in a Swiss bank.

• The market in which the borrowing and lending of these balances takes place is the Eurocurrency market.


Eurocurrency or Offshore Financial Markets

• Reasons for Offshore Deposits – Interest rates on short term deposits abroad are often higher than domestic rates. – International corporations often find it convenient to hold balances abroad for short periods in currency they need for payments. – International corporations can overcome domestic credit restrictions by borrowing in the Eurocurrency market. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Eurocurrency or Offshore Financial Markets • Eurobonds - long-term debt securities sold outside the borrower’s country to raise long-term capital in a currency other than the currency of the nation where the bonds are sold. • Euronotes - medium-term financial instruments used by corporations, banks and countries to borrow mediumterm funds in a currency other than the currency in which the notes are sold.


APPENDIX E • • • •

PEOPLE’S BANK OF CHINA (PBC) PBC: INTERNATIONAL DEPARTMENT GINI INDEX CHINA’S “SILK ROAD”

PBC: International Department • Responsible for official contacts and business cooperation between the PBC and the – international financial organizations, – foreign central banks, – and financial authorities in Hong Kong and Macao SARs – and Taiwan

PBC: International Department cont. • coordinating opening of the domestic financial industry in accordance with the commitments made by the Chinese government when joining the WTO; • undertaking foreign affairs of the PBC; • and supervising operations of the PBC foreign offices.

Gini Index • Standard economic measure of income inequality, based on Lorenz Curve. • A society that scores 0.0 on the Gini scale has perfect equality in income distribution. • Higher the number over 0, higher the inequality, and the score of 1.0 (or 100) indicates total inequality where only one person corners all the income. Named after its inventor, the Italian statistician Corrado Gini (1884-1965).

Silk Road or Silk Route • Refers to a historical network of interlinking trade routes across the Afro-Eurasian landmass that connected East, South, and Western Asia with the Mediterranean and European world, as well as parts of North and East Africa. • The land routes were supplemented by sea routes which extended from the Red Sea to East Africa, India, China, and Southeast Asia.

APPENDIX F • OFFSHORE BANKING: INTRODUCTION

Offshore Banking cont. • Legally, offshore banking does not prevent assets from being subject to personal income tax on interest. • Offshore banks may decide not to report income to other tax authorities, and have no legal obligation to do so as they are protected by bank secrecy

Offshore Banking cont. • Following September 11, 2001, there have been many calls for more regulation on international finance, in particular concerning offshore banks, tax havens, and clearing houses, being possible crossroads for major illegal money flows.

Offshore Banking cont. • Defenders of offshore banking have criticized these attempts at regulation. • They claim the process is prompted, not by security and financial concerns, but by the desire of domestic banks and tax agencies to access the money held in offshore accounts. • They cite the fact that offshore banking offers a competitive threat to the banking and taxation systems in developed countries.

Offshore Banking: Advantages • Provide access to politically and economically stable jurisdictions. • May operate with a lower cost base and can provide higher interest rates • One of the few industries, along with tourism, in which geographically remote island nations can competitively engage. • Interest is generally paid by offshore banks without tax being deducted.

Offshore Banking: Advantages cont. • May offer banking services that may not be available from domestic banks • Often linked to other structures, such as offshore companies, trusts or foundations, which may have specific tax advantages for some individuals • Tax and banking competition allows people to choose an appropriate balance of services and taxes.

Offshore Banking: Disadvantages • Offshore bank accounts are less financially secure • Offshore banking has been associated in the past with the underground economy and organized crime, through money laundering • Offshore jurisdictions are often remote, so physical access and access to information can be difficult.

Offshore Banking: Disadvantages cont. • More accessible to those on higher incomes, because of the costs of establishing and maintaining offshore accounts. • Often touted as the solution to every legal, financial and asset protection strategy but his is often much more exaggerated than the reality.

Offshore Banking Statistics • As much as half the world’s capital flows through offshore centers • Tax havens have 1.2% of the world’s population and hold 26% of the world’s wealth • This includes 31% of the net profits of US MNCs

Offshore Banking Statistics cont. • One third of the wealth of the world’s “high net-worth individuals”, $6t out of $17.5t, may be held offshore • IMF indicates that $1t of illicit money is laundered annually • Offshore is where most of the world’s drug money is allegedly laundered, est. $500b a year

Offshore Banking Statistics cont. • Another $500b is the proceeds of tax evasion. • Another $200-300b come from fraud and corruption • Swiss banks hold an estimated 35% of the world’s private and institutional funds ($3t) • Cayman Islands banks hold another ($1.9t)

Offshore Banking Statistics cont. • Other Offshore banking centers include: – – – – – – – – –

Antigua and Barbuda Bahamas Barbados Belize Bermuda British Virgin Islands Channel Islands Cook Islands Cayman Islands

Cyprus Dominica Ghana Hong Kong Isle of Man Labuan, Malaysia Liechtenstein Luxembourg, etc.

Regulation of Offshore Banking • Initiatives have increased since the late 1990s, especially after September 11, 2001: – Tightening of anti-money laundering regulations in many countries – In the US the IRS introduced Qualifying Intermediary requirements (names of the recipients of US-source investment income are passed to the IRS

Regulation of Offshore Banking cont. • Following 9/11 the US introduced the USA PATRIOT Act, which authorizes the US authorities to seize the assets of a bank, where it is believed that the bank holds assets for a suspected criminal • The EU has introduced sharing of information between certain jurisdictions

Weakened Bank Secrecy • OECD won’t object to governments using stolen bank data to track down tax cheats in offshore centers • OECS may sanction countries that do not offer sufficient tax transparency • (UBS recently shared confidential bank details about 285 clients suspected of willful tax evasion by the US IRS)