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Cablegate: U.S.-China Strategic & Economic Dialogue: Shanghai Observers

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E.O. 12958: N/A
TAGS: CH ECON EFIN EINV PGOV
SUBJECT: U.S.-CHINA STRATEGIC & ECONOMIC DIALOGUE: SHANGHAI OBSERVERS
UNCERTAIN ABOUT FUTURE OUTCOMES

1. (SBU) Summary: Shanghai financial sector representatives
generally acknowledge the symbolic and confidence-building value
of the U.S.-China Strategic and Economic Dialogue (S&ED),
although many are uncertain about the actual economic impact of
the discussions. End summary.

============================================= ==================
The S&ED Strikes the Right Tone . . . But Can It Hold the Tune?
============================================= ==================

2. (SBU) Our contacts in Shanghai's financial services sector
-- including U.S. and European banks, domestic and international
fund managers and securities houses, and Chinese scholars --
confirmed that S&ED messaging crafted in the United States has
reached the intended audience in Shanghai. Many sources
recognized or employed key U.S.-derived phrases such as
"long-term, strategic engagement," or "positive, cooperative,
and comprehensive relationship." The overwhelming majority of
our contacts emphasized that the Chinese attach great importance
to the S&ED and appreciate the Obama Administration's efforts to
set a positive tone -- one that recognizes differences between
the two countries while striving to advance common goals. A
contact at the Shanghai Academy of Social Sciences (SASS),
however, wondered how the U.S.-China relationship will shift
once recovery is assured. He worried that the United States
might be more aggressive towards China after the financial
crisis, when the United States has less of a need for Chinese
cooperation.

3. (SBU) Despite initially positive feedback, some of our
contacts expressed uncertainty about the S&ED's ability to
convert positive sentiment into tangible outcomes in both the
short and long terms. For example, a vice chairman of the
Shanghai Institutes for International Studies (SIIS) praised the
S&ED framework for what it set out to achieve, and said he was
satisfied by the first round of the Dialogue. Yet, he also
expressed fear that (i) the S&ED might just be a "talk shop",
where nothing is actually accomplished, and (ii) that future
meetings would digress into very specific, less strategic issues
like its predecessor, the SED, did. The vice chairman expressed
concern that the S&ED might be "old wine in a new bottle" --
that it would not live up to its goal of addressing the most
important long-term strategic issues facing both countries.

============================================= ==========
Concern on Market Economy Status, Safety of U.S. Assets
============================================= ==========

4. (SBU) Market Economy Status (MES) was the most frequently
raised concern when discussing S&ED outcomes. Our Chinese
contact at a securities house asked how China could be granted
MES, while the vice chairman of SIIS pushed for a better sense
of the timeline of when this could be achieved. He described
the failure to grant China MES as another form of protectionism
-- like regulation of high-tech trade or restrictive U.S. import

SHANGHAI 00000372 002 OF 004


tariffs on Chinese tires -- to which China should not be
subjected. This contact said he was concerned about increasing
nationalism, protectionism, and trade conflicts between the
United States and China, as well as the role the U.S. Congress
plays in inflaming these issues. He advocated for educating
domestic audiences in both the United States and China so that
uninformed public opinion does not get in the way policy-making.

5. (SBU) Our contacts also raised the issue of China's role in
international financial institutions. Our contact at SASS asked
how reform of international financial architecture as mentioned
in the Economic Joint Fact Sheet issued following the S&ED would
come to fruition, given the fact that each country is acting
according to its own interest and not necessarily in support of
the whole system. He asked about what the United States will
propose with regard to special drawing rights (SDR) and
utilizing the renminbi as part of the SDR currency basket,
adjusting IMF quotas, and "recognizing the demand" for moving
away from the U.S. dollar as world's reserve currency. He
stated that if the United States neglects the demand for
stability in the markets by maintaining the hegemony of the
dollar, sooner or later it could lead to another crisis. A few
of our Chinese contacts sought insight into whether the United
States will be shifting away from the G8 as the power base for
an international economic governing body and towards the G20,
due to the G8's "recent loss of credibility."

6. (SBU) Officials at the Shanghai Stock Exchange and other
Chinese institutions stated their concern with requiring Chinese
companies to conform to Generally Accepted Accounting Principles
(GAPP). According to one source, this regulation would impose a
$10 million one-time cost on Chinese companies. This could be
avoided if the United States were to accept Chinese accounting
standards.

7. (SBU) A few contacts stressed the safety of U.S. assets as
their primary concern. Our contact at SASS and a well-respected
Shanghai-born source at a U.S. bank said some Chinese economists
worry the U.S. Federal Reserve will not be able to absorb extra
liquidity when the U.S. economy recovers. Our Shanghai-born
banking source stated his belief that the U.S. Federal Reserve
can never de-lever its balance sheet, except at the expense of
economic growth -- reinforcing the point that this will never
happen, he said. He expressed concern that inflationary
pressure in the U.S. would spread to the world economy. Our
SASS contact also stated that quantitative easing should not be
permitted, and noted the risk of inflation posed by some of the
U.S. Federal Reserve's actions. In contrast, other financial
sector contacts -- both American and Chinese -- dismissed fears
of pending inflationary pressure in the United States.

8. (SBU) A number of conversations also revealed Chinese
concerns related to the United States' fiscal deficit. The
first question in a list of concerns raised by a general manager
of a Shanghai securities house was "how can the United States

SHANGHAI 00000372 003.2 OF 004


guarantee the safety of U.S. assets in light of the fiscal
deficit?" A professor from Tongji University expressed Chinese
worries about a possible depreciation in the value of Chinese
investments in U.S. Treasuries.

============================================= ========
U.S. Financial Sector Concern About Market Access and
Implementation of Outcomes
============================================= ========

9. (SBU) For U.S. participants in Shanghai's financial services
sector, market access for foreign banks in China remains a
sticking point. Many were critical of the U.S. government for
not doing more to advance this issue. Senior representatives
from two U.S. banks and a third asset management fund declared
that U.S. companies are still hindered by stringent control of
ownership, slow licensing processes, and opaque approval
systems. Our U.S. contacts routinely objected to restrictions
on ownership of joint ventures and the 20 percent ownership cap
imposed on individual financial firms' investments in local
banks.

10. (SBU) Our U.S. sources in Shanghai, while recognizing the
positive framework of the S&ED, frequently questioned how
agreements coming out of the S&ED would actually be implemented,
a concern that muted their full endorsement of the dialogue.
Three contacts at a U.S. bank stated that implementation of some
of the previous Strategic Economic Dialogue (SED) outcomes
remains unclear. For example, foreign banks were approved to
underwrite Chinese corporate bonds in December 2008, through SED
V. However, eight months later, no U.S. bank has actually
underwritten any corporate bonds. Several others expressed the
view that more systematic processes and improved transparency
are necessary to drive real progress on outcomes from the S&ED
and also to advance Shanghai as an international financial
center. One contact said that without a good system, U.S. banks
will continue to work alone, forging one-off deals with the
Chinese government that serve to box-out other U.S. financial
sector participants. On a more positive note, several of our
sources noted that getting new products to market has been
slightly easier than trying to become an underwriter, but this
process also lacks a systemized, transparent approach.

=============================================
Fine-Tuning Market Liberalization Discussions
=============================================

11. (SBU) According to a contact at Gaohua Securities
(Goldman's JV) and our source at SASS, the S&ED I agreement to
liberalize interest rates is not critical to Shanghai's
development as an international financial center. Our contacts
argue that lending rates have been liberalized significantly.
They explained that banks can charge different interest rates
according to credit worthiness as long as they stay within the
People's Bank of China's broad range of permissible rates.

SHANGHAI 00000372 004 OF 004


Additionally, the liberalization of interest rates will not
cause a shift in capital efficiency or an increase in domestic
consumption, the SASS source said, because interest rates are
high as compared to the rest of the world. (Comment: There
remains a floor for lending rates, meaning the most creditworthy
borrowers pay a higher interest rate than they otherwise would
absent the controls. In addition, the difference between
inflation-adjusted growth and lending rates in China, averaged
over the course of a macroeconomic cycle, remains one of the
highest in the world, contributing to excessively
capital-intensive growth. End comment.)

12. (SBU) One of our contacts explained that it is more
important to remove the ceiling on deposit rates than the floor
on lending rates. The ceiling (currently 2.25%) is set by the
People's Bank of China, and no bank is allowed to give higher
rates. At this time, he said, even though banks have more money
than they can lend, they still aim to increase market share.
Yet they cannot attract deposits by increasing rates. To get
around this, banks can and do create different incentive
structures and products. For example, they might give cash
rebates (both formal and informal) to corporate treasurers to
attract deposits. (Comment: The inability of banks to compete
on price constrains the growth of the most efficient banks.
Furthermore, low inflation-adjusted returns on financial assets
are one reason the growth of household income has trailed GDP
growth, leading to a steady decline of household consumption as
a percent of GDP. End comment.)

=======
Comment
=======

13. (SBU) The S&ED is widely recognized by our Shanghai sources
as an opportunity for the United States and China to work
constructively on a host of financial issues of critical
importance. However, our contacts are not yet convinced that
the S&ED will be able to resolve issues of importance in a
timely manner. The renewed emphasis on gaining Market Economy
Status for China reflects deep-seated worries about U.S.
measures that could inhibit China's capacity to exploit future
U.S. demand for Chinese-made goods as the American economy
recovers.
CAMP

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