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Cablegate: Codel Hagel: Chinese Thoughts On World Financial

VZCZCXRO6922
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #3949/01 2900923
ZNR UUUUU ZZH
P 160923Z OCT 08
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 0471
INFO RUEHOO/CHINA POSTS COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUCPDOC/USDOC WASHINGTON DC PRIORITY
RHEHNSC/NSC WASHDC PRIORITY
RUEHKO/AMEMBASSY TOKYO 2282
RUEHUL/AMEMBASSY SEOUL 0980

UNCLAS SECTION 01 OF 04 BEIJING 003949

FRANCISCO FRB FOR CURRAN/GLICK; NEW YORK FRB FOR
CLARK/CRYSTAL/DAWSON
STATE PASS CFTC FOR OIA/GORLICK
CEA FOR BLOCK
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND OCEA/MCQUEEN
TREASURY FOR AMB.HOLMER, WRIGHT AND TSMITH
TREASURY FOR OASIA - DOHNER/HAARSAGER/CUSHMAN
TREASURY FOR IMFP - SOBEL/MOGHTADER
NSC FOR LOI
STATE FOR EAP/CM AND EEB/OMA

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON EINV PREL PGOV CH
SUBJECT: CODEL HAGEL: CHINESE THOUGHTS ON WORLD FINANCIAL
CRISIS

Reftel: 1) 08 Beijing 03857 2) Paulson-Wang Qishan telcon
Oct 11, 2008

(U) THIS MESSAGE IS SENSITIVE BUT UNCLASSIFIED. PLEASE
HANDLE ACCORDINGLY. NOT FOR INTERNET DISTRIBUTION

1. (SBU) Summary: On October 13-14, Senator Charles Hagel
met Chinese Vice Premier Wang Qishan, Central Bank Governor
Zhou Xiaochuan, and Commerce Vice Minister Ma Xiuhong. The
Vice Premier discussed weaknesses in the U.S. system that
had led to the financial crisis, and asserted China's
commitment to cooperate with the United States to resolve
the situation, including continuing to buy U.S. debt.
Regarding a U.S.-raised G-20 summit idea, Wang noted that
the meeting had failed to materialize despite an agreement
to attend on China's part, but saw the Chinese quick
response to the offer as a positive sign. Wang expressed
hope that the incoming Administration would move quickly to
clarify their China policies, noting that bilateral
meetings such as the Strategic Economic Dialogue (SED) had
increased confidence. Although China and the United States
would disagree on some issues, and arms sales to Taiwan
were regrettable, Wang anticipated continuing the
constructive relationship. Governor Zhou and Vice Minister
Ma likewise both noted opportunities for cooperation to
stabilize financial markets, including a Chinese focus on
growing their economy. They saw opportunities for China to
continue to reform its economy. End summary.

ang Qishan: Cause of Crisis
----------------------------

2. (SBU) Vice Premier Wang Qishan outlined what were in his
view the major contributing factors in the U.S. financial
crisis: 1) a lifestyle of low savings and high consumption;
2) excessively loose monetary policy and liquidity creation
in response to the bursting of the Internet stock bubble
and September 11; 3) excessive financial innovation
combined with insufficient regulation and supervision, with
financial assets priced on complex models that even bank
CEOs did not understand; and 4) weak internal risk
management, including excessive leverage of financial firms
and executive compensation arrangements that paid large
bonuses for strategies that led to large losses.

3. (SBU) Wang said the proliferation of poorly understood
financial derivatives had greatly increased financial
leverage in the system. The volume of credit default swaps
is 62 trillion dollars, far outstripping any basis in the
real economy. The bursting of the housing bubble had led
to a rapid shift from excess liquidity to a liquidity
crisis, threatening a collapse of the entire global credit
system and affecting the real economy.

Commitment to Cooperate
-----------------------

4. (SBU) Wang said the Chinese government is very "sober-
minded" in facing the crisis. Although the problems
started in the United States, the crisis affects the whole
world and China is greatly impacted by what happens on Wall
Street. Wang estimated that Chinese holdings of U.S.
Treasury securities, U.S. agency debt, and corporate stocks
totaled USD 1.2 -1.3 trillion.

5. (SBU) Wang supported the USG policy responses to date
and is committed to continue cooperation. He noted that
the People's Bank of China (PBOC) issued a strong statement
of support at the financial markets' most difficult moments,
adding that last week China appeared more confident about
the prospects for passage of a financial rescue passage
than most Americans. China will also contribute to the
global economy by keeping its own growth strong, which is
why the Chinese monetary policy was loosened last week. He
said that China would implement a range of policies to keep

BEIJING 00003949 002 OF 004


domestic demand growth steady, as he expects 2009 will be a
"most difficult" year for demand in China's major trading
partners and thus for China's economy.

6. (SBU) Wang stressed that China is cooperating in deeds,
not just words. China has not sold its holdings of U.S.
agency debt. In response to USG requests, Wang said China
recently bought new U.S. agency bonds. (Note: According to
officials of the State Administration of Foreign Exchange,
they have maintained their overall holdings of U.S. agency
bonds, although they have switch their Fannie Mae and
Freddie Mac holdings from long-term to short-term bonds.
End Note.) In his view, Senator Hagel said the U.S.-China
bilateral relationship is as important as any in dealing
with the financial crisis. He said China can rest assured
that the Congress will support the Federal Reserve, the
Treasury, and the next President to stabilize the financial
system, noting the United States will not fail to rise to
the challenge of ensuring a prosperous economy. He noted
that the United States will inject fresh capital into
financial institutions and stand behind the obligations of
Fannie Mae and Freddie Mac.

Summit Response
---------------

7. (SBU) Wang noted that China's quick positive response to
the U.S request that President Hu attend a leaders' summit
on October 18 was "unprecedented" and demonstrated China's
preparedness to be a responsible member of the global
community (see ref telcon.) The request was received on
October 10 and by October 12 China had confirmed that
President Hu would attend. The MFA and the Embassy in
Washington had already made considerable preparations,
including booking hotel reservations. However, Wang said
he had heard earlier in the day from U.S. officials that
due to internal G-7 divisions, the October 18 leaders'
meeting is cancelled. He noted how the U.S.-China
relationship had changed: in the past, the United States
would decide whether to have a multilateral meeting and
then informed China, while now it reached out to China in
advance of a decision.

Hopes for New Administration
----------------------------

8. (SBU) Wang noted that while past Administrations have
taken 1-2 years to clarify their China policies, he
expected the next Administration would move much more
quickly. He stressed that China needs a constructive and
cooperative relationship with the United States for China
to have a "peaceful" external environment so its can
achieve its development goals. Globalization is an
unstoppable force, he stated, and the U.S. and China's
interests are inextricably intertwined.

9. (SBU) Senator Hagel agreed that the next President will
not have the luxury of time to put his policies in place
and would have to act quickly to map out their strategy for
solving the financial crisis. He said that both Senators
Obama and McCain understand the fundamental relationship
between the United States and China, stressing that the two
countries are intertwined and a "divorce" is not possible.

Larger Relationship, SED, and Taiwan
------------------------------------

10. (SBU) Wang noted appreciation for the collaborative
approach to bilateral relations established under the
Strategic Economic Dialogue (SED) and highlighted that the
SED had laid the groundwork for senior officials to be able
to communicate daily. Through the SED and the Joint

BEIJING 00003949 003 OF 004


Commission of Commerce and Trade (JCCT), issues important
to either side are on the table for discussion, including
IPR, investment, energy and the environment, high-
technology trade, food and product safety, and agricultural
trade.

11. (SBU) On the broader U.S.-China relationship, Wang said
there was no difference on fundamental interests. In his
view the main disagreements were over the "internal
sovereign issues" of Tibet, Taiwan, and Xinjiang. Wang
appreciated U.S. support for the Beijing Olympics, and said
the President's visit at a time of financial stress in the
United States was warmly received. However, he expressed
concern about the recent arms sale to Taiwan. In Wang's
view, the weapons were less of a concern than the signal
the sale provides that will embolden supporters of Taiwan
independence. He noted the timing was regrettable as
U.S.-China relations had improved after Chen Shui-bian's
election loss Nevertheless, Wang said China would continue
to cooperate with the United States on coordinated
responses to the financial crisis. Senator Hagel agreed
that, while the U.S. and China will continue to have
differences, these differences should not be allowed to
frame the relationship.

Central Bank: Chinese Response to Situation
--------------------------------------------

12. (SBU) At his meeting with Senator Hagel, PBOC Governor
Zhou Xiaochuan noted that China is following the U.S.
financial turmoil closely, both because Chinese economic
and financial markets are now integrated into global
markets, and because China is a major investor in U.S.
Treasuries and government agency securities. Noting that
he did not speak for the Congress or any Administration,
Senator Hagel sought to reassure Governor Zhou that Fannie
Mae and Freddie Mac might emerge in a few years with
different structures, but the U.S. government would stand
behind the organizations. Zhou hailed the major central
banks' coordinated action to "rescue" the financial system.

13. (SBU) Governor Zhou noted that he would see Secretary
of Treasury Paulson and Federal Reserve Chairman Bernanke
this weekend. (Note: This was an apparent reference to the
suggested summit referenced by Wang Qishan. End note.)

14. (SBU) Zhou said the Chinese Government and the PBOC are
prepared to do whatever is necessary to assist in
stabilizing markets, including injecting liquidity into the
Chinese market. The Chinese financial markets, however,
are still "not sophisticated" and capital income is low, so
China is not as affected by the unrest in the global
financial markets.

15. (SBU) Moving forward, Zhou said that the Government's
economic goals had shifted suddenly from "controlling
inflation" to providing a "flexible and prudent" response
to the global situation. Following the Third Party Plenum
this weekend (see reftel), the PBOC was now hard at work
developing a "probably temporary" response package. (Note:
At the Politburo-level meeting that ended on Monday,
leaders had been expected to discuss appropriate fiscal and
monetary measures to respond to tighter global credit
conditions and falling demand in China's major export
markets. End note.)

Macro and Rural Reform
-----------------------

16. (SBU) Turning to rural reform, the official focus of
the Plenum, Zhou noted that, because China needs to control
migrant labor, the land reform process must be orderly. He

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thought that the size of farms would remain small, but
farmers would be allowed to diversify their activities to
maximize production. (Embassy comment: Observers had
expected that the Plenum to move forward on land reform,
allowing farmers to transfer and consolidate land to
improve productivity and yields. Some social critics had
worried that this would create a class of landless peasants
if the economy slowed. Zhou's comments may indicate that
concerns over migrant labor may have tempered enthusiasm
for sweeping land reform at the Plenum. End comment.)

17. (SBU) He said the government for the past five years
has encouraged farmers entering the work force to move into
non-export dependent industries. This was part of an
effort to transition China from an export-led to a domestic
consumption-led economy. The Chinese people, however, due
their long experience with shortages, tended to have high
consumption rates. That said, retail sales growth was
strong, and service sector demand was gradually increasing.

Commerce Ministry: Collaboration, not Protectionism
--------------------------------------------- ------

18. (SBU) Commerce Vice Minister Ma said China fully
understands the gravity of the financial crisis. She said
China first will continue to work with other major
economies to cooperate in solving the financial crisis.
Second, China would continue to reform and open its economy,
and oppose protectionist measures and sentiments.
According to Ma, China has had great success in increasing
U.S. exports to China, and increased Chinese demand will
create opportunities for U.S. exporters. Increased Chinese
demand for nuclear and clean energy technologies also
creates opportunities for U.S. technology exports. Third,
as world demand slows, China will stabilize its own growth
through stimulating domestic consumption, including through
the implementation of measures delineated at the Third
Plenum of the 17th Party Congress. Maintaining China's
internal economic stability in itself contributes to global
stability.

19. (SBU) Both sides discussed the importance of
international cooperation in addressing the financial
crisis, and emphasized the common interest in opposing
increased protectionist sentiment. Vice Minister Ma noted
that changes in U.S. presidential administrations present
challenges in our bilateral relations.

20. (U) THIS CABLE HAS BEEN CLEARED BY THE DELEGATION.

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