Cablegate: October 19-20 Visit of Treasury U/S Mccormick To

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1. (SBU) Summary. Vice Premier Wang Qishan and other senior
Chinese financial officials told U/S McCormick on October
20 that China welcomed recent U.S. Government actions to
address the financial crisis. People's Bank of China
Governor Zhou Xiaochuan and other officials raised
questions about the continuity of U.S. policies into the
next administration. Zhou noted that some senior Chinese
leaders are not fully aware of the extent of USG guarantees
of U.S. banks' liabilities and commitment on Fannie and
Freddie debt. Interlocutors stressed that unless leaders'
concerns about the viability of banks and U.S. government-
sponsored enterprises (GSEs) are assuaged, lower level
officials will be constrained from taking on greater
counter-party risks or extending the maturity of the
Chinese government's GSE holdings. Zhou emphasized that,
while the pace of RMB appreciation might slow periodically
due to China's domestic factors, the decisions about its
medium-term path have been made and the U.S. "should not
worry." Interlocutors said that while Chinese leaders and
businessmen welcome the message that the U.S. is open to
Chinese investment (including in the financial sector),
they remain cautious, having suffered large financial and
political setbacks from U.S. investments, including in
Blackstone and the Reserve Fund. End Summary.

2. (SBU) During his October 19-20 visit to Beijing,
Treasury U/S David McCormick briefed Vice Premier
Wang Qishan and senior officials at the Ministry of
Finance (MOF), People's Bank of China (PBOC), China
Banking Regulatory Commission (CBRC), and China
Securities Regulatory Commission (CSRC), as well as
leaders of the China International Capital
Corporation (CICC) and China Investment Corporation
(CIC), on the four-part U.S. policy approach to
stabilizing the markets and economy: 1) the Federal
Reserve's purchase of commercial paper to inject
liquidity; 2) the Securities and Exchange
Commission's actions to safeguard market integrity
and prevent market manipulation (including through
limits on short-selling); 3) the Federal Deposit
Insurance Corporation's guarantee of banks' short
and medium-term liabilities (including non-interest
bearing accounts) in order to assuage concerns about
counter-party risks; and 4) Treasury's pledge to
inject $700 billion into the U.S. banking sector,
either through increased capital or purchases of
impaired assets. In each meeting, U/S McCormick
also emphasized that even though the U.S. government
did not explicitly guarantee GSE debt, it
effectively did so by committing to inject up to
$100 billion of equity in each institutions to avoid
insolvency and that this contractual commitment
would remain for the life of these institutions. He
also stressed importance of the next session of the
Strategic Economic Dialogue (SED), and in particular
the importance of having tangible results, as both
financial markets and the next administration will
be watching and assessing the SED's merits.

Vice Premier Wang Qishan

3. (SBU) Vice Premier Wang welcomed recent U.S. Government
actions, saying they had addressed liquidity problems but
had not solved equity market nor distressed debt problems.
He speculated that the United States will have to
recapitalize lenders, and expressed concern that the Fed's
liquidity injects could lead to inflation if the US economy
recovers next year. Wang emphasized that China's leaders,
including President Hu Jintao and Premier Wen Jiabao, do
not want to see problems in the U.S. economy. (Comment:
Wang was likely responding to articles in the Chinese press
and on the web that had initially welcomed the financial
disorder as the demise of U.S. economic "hegemony." End
comment.) U/S McCormick assured Wang that it would require
an unprecedented act of Congress to renege on the contracts
made to guarantee Fannie Mae and Freddie Mac debt. He also
explained that Chinese investment in financial services
companies would be welcomed, and the Federal Reserve would
be responsible for approving investments in banks and bank
holding companies.

BEIJING 00004074 002.2 OF 004

4. (SBU) The Vice Premier praised Secretary Paulson's use
of the Strategic Economic Dialogue (SED) mechanisms to
coordinate with China throughout the crisis. Wang
stated that the Chinese government attaches great
importance to the SED, and both Hu and Wen had spoken
positively of the forum's form and substance. Wang
noted that in the U.S. media, some observers had
focused on the need for the SED to deliver
concrete results, while others -- including Senator Obama
in a recent interview -- had emphasized the strategic
economic relationship. Wang agreed with U/S McCormick that
the SED needed to cover both tactics and strategy.

People's Bank of China

5. (SBU) PBOC Governor Zhou Xiaochuan inquired about the
continuity of U.S. policies during the transition to the
next U.S. administration. On US agency debt, Zhou
understood that the USG stands behind Fannie and Freddie
debt fully, but believed that senior leaders as well as
lower-level bank officers were not fully cognizant given
that the USG did not explicitly guarantee the debt and
uncertainly remains about the GSE's long-term structure and
roles. Similarly, Zhou agreed that depreciation of the RMB
against either the USD or on a trade weighted basis at a
time when demand in its major trading partners is weakening
could be politically sensitive for China's trading partners,
but added that this issue was not simple for China's top
leadership. Zhou said he believes it remains important
that prices signals from a more appreciated exchange rate
promote a reduction in China's domestic and external
imbalances, but the State Council felt pressure to signal
support for the export sector by limiting appreciation the
RMB. Given the expected sharp decline in external demand,
Zhou said he did not think it useful or effective to try to
promote exports by holding down the price of Chinese
exports through the exchange rate, but that it was
difficult to get a policy consensus for this. Zhou added
that periodic pauses in the pace of RMB appreciation should
not be a concern to the U.S. as long as the long-term
trajectory remained the same. On Chinese investment in the
U.S., Zhou said some Chinese political and business leaders
appreciate the U.S. open investment message, but remain
cautious after the losses suffered on investments to date,
including Blackstone and the Reserve Fund investment by CIC.
Despite encouraging rhetoric from senior USG officials,
they also doubt that the regulatory and political climate
is open to Chinese investment, including CFIUS.

6. (SBU) Zhou expressed appreciation for U.S. assistance in
China gaining membership in the IDB, as well as for the
granting of a bank branch license to ICBC. He added that
neither issue was of particular importance to the PBOC
itself, but that they had to pursue them vigorously on
behalf of other constituencies, notably MOFCOM for the IDB.
More generally, Zhou noted his appreciation for the ongoing
close communication with Treasury. He added that, after
the Lehman Brothers' bankruptcy, Chinese banks remained
nervous about counter-party risk in dealing with foreign
banks. He assured McCormick that the PBC would take steps
to ensure foreign banks have access to liquidity, which
was why the PBOC had decided recently to raise, on a
temporary and exceptional basis, the foreign banks' foreign
currency debt quota to allow them to access financing from
their overseas parents. Zhou said PBOC is also considering
establishing a liquidity facility for banks similar to the
one adopted by the Hong Kong Monetary Authority.

Ministry of Finance

7. (SBU) Minister of Finance Xie Xuren told U/S
McCormick that China viewed a sound U.S. economy as
in the best interest of the world economy, and that
both President Hu Jintao and Premier Wen Jiabao
placed great importance on international cooperation
to resolve the financial crisis. For the upcoming
SED, Xie said he hoped the December session would
include discussions on the lessons of the financial
crisis and how to limit financial turmoil in the
future. He suggested that China and the U.S. should
discuss how to increase market liquidity and
confidence along with financial supervision and how

BEIJING 00004074 003.2 OF 004

to balance best financial innovation with financial

China Banking Regulatory Commission

8. (SBU) CBRC Chairman Liu Mingkang responded favorably to
recent USG actions. He also expressed interest in
continuing close cooperation with the U.S., and emphasized
the need for global coordination. Looking ahead, Liu
commented that hedge funds and private equity may by "the
next shoes to drop" and said China would take further
stimulatory measures to guard against economic risks. Liu
noted the need to delegate more loan decision-making
authority to local bank managers, and to provide more
financing to small and medium enterprises. Liu also
advocated support for housing markets through more
favorable loan terms (Comment: the government recently
reduced down payments for first time buyers of small
apartments). He said the decline in global energy prices
would give China an opportunity to lift price controls.
Finally, Liu asked for the Chinese government to be
informed before U.S. strategic investors dump their shares
in Chinese banks, when the lock-up period ends.

China Securities Regulatory Commission
9. (SBU) CSRC Vice Chairman Yao Gang said the CSRC is
working with the New York Stock Exchange to resolve legal
issues and enable foreign firms to issue depository
receipts in Chinese markets. For credit rating agencies,
Yao said CSRC would accept license applications from joint
venture companies after the SEC issues revised regulations
covering their operations as agreed to at SED IV. Finally,
Yao confirmed that the CSRC report on foreign involvement
in China's capital markets would be completed by the end of
the year.
China International Capital Corporation

10. (SBU) CICC CEO Levin Zhu observed that China's "over-
built" export sector would be severely impacted by any
recession in the U.S. CIIC Chief Economist Ha Jiming said
China's unemployment rate, currently about six percent,
would rise over the next two years and reduce consumption
growth. He believed China's economy would "slow
significantly." Export growth would fall due to three
factors: the exchange rate, declining external demand, and
the credit crunch; regarding the latter, Ha said the PBOC
was instructing Chinese banks to lend to exporters, but the
banks were increasingly unwilling to do so given concerns
about exporters' prospects. As a result, he believed real
GDP growth would decline to about seven percent in 2009,
absent any significant policy adjustments. Ha also
believed the government's ability to respond with a
stimulus package, which CEO Zhu opined was probable, would
be limited due to sharply decelerating revenue growth. The
"good news," said Ha, was that the government has the
capacity to undertake fiscal stimulus without raising
concerns about fiscal sustainability as public debt is very
low as a percent of GDP.

11. (SBU) Ha believed there would be "lots of political
pressure" if the RMB continued to appreciate against the
USD, while the USD appreciated against the Euro and the
currencies of China's other major trading partners;
furthermore, the EU was not taking pre-emptive actions and
faced a much larger housing bubble than the U.S. As a
result, he viewed the euro as "shaky." Overall, Ha
concluded that the financial crisis would cause China to
become more cautious regarding financial sector reform.

China Investment Corporation

12. (SBU) China Investment Corporation (CIC) General
Manager Gao Xiqing said CIC had been preparing daily
reports to the State Council, along with other Chinese
agencies on its exposure to potential losses on overseas
investments. Gao stressed that it would be problematic if
it was viewed in China that the USG offered preferential
treatment to certain countries and/or companies, such as
Japan and Mitsubishi's investment in Morgan Stanley. U/S
McCormick assured Gao that the guidelines applied to CIC
and China would be consistent with those for other

BEIJING 00004074 004.2 OF 004

investors, and noted that the U.S. Treasury's equity
injection in Morgan Stanley had protected CIC's stake by
having an equal, and not senior, claim. McCormick urged
CIC to consider and consult with the USG on potential
investments in the U.S. financial sector. Gao indicated
that CIC now was comfortable with the situation of its U.S.
money market investments, and said they currently did not
own any Fannie Mae/Freddie Mac debt but were considering
purchases. CIC, while more confident now, still retained
concerns about continuation of the USG's new policies and
programs under the next administration. CIC also was
concerned about the impact of the financial crisis on the
real economy, which they believe will slow further and
cause a "bumpy ride" for stock markets. They also
questioned the inflationary impact of issuance of large
volumes of treasuries. Finally, Gao noted that one reason
CIC tries to avoid CFIUS is that the CIC board of directors
(vice ministers of various government agencies) have
concerns about having to report personal information to


13. (SBU) All of U/S McCormick's counterparts appeared to
appreciate his willingness to come to Beijing in the midst
of a financial crisis. Securities regulators subsequently
told FINATT that the State Council financial crisis working
group under Vice Premier Wang Qishan subsequently met to
discuss McCormick's visit. The overarching message from
his interlocutors is that the Chinese government wants to
play a constructive role (and at the very least does not
want to do anything destabilizing) as financial and
economic weakness in the U.S. have financial, economic and
political costs in China and to its leaders. Technocrats
stressed the importance of explaining the policy
implications of USG actions to assuage senior leaders' and
State Councilors' concerns about the durability of U.S.
policy responses into the new administration. This
highlights the importance of not only engaging with Vice
Premier Wang, but also other economic ministries such as
Finance, which report to other Vice Premiers. On the SED,
the relevant Chinese agencies reconfirmed the usefulness of
the SED, and also their strong interest in and support for
a successful SED session in December.


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