tv Discussion on Chinas Trade Conflicts Financial Systems CSPAN April 24, 2019 5:01pm-6:25pm EDT
>> do we have the microphones? >> a lot of people interact with the court without a lawyer. is there any way the legal profession can help get more people representation, these millions of cases every year? >> i hope so. you mean the cases in the courts generally? >> yes, sir. >> we will appoint somebody to represent if we take the case. but you mean in general, the legal profession? i know they try, the bar associations, and here is a kind of dilemma for you to think about. in britain, they pay a lot more money than we do for legal aid, and in france, they still pay more money than we do but not a lot more. so i've asked them how is it
possible you get more legal representation and yet it doesn't cost you a lot of money. >> tail end of a lovely afternoon like this, aggressively blue windowless room like this. i think you made the right choice. i'm michael sutherland, editor of the official journal of johns hopkins sites and flagship publication of the foreign policy institution. it's been the goal of the foreign policy institute here at sais to search for realistic answers to international issues facing the united states and the world today. now, as attested to by today's turnout we are here to talk about one of the most consequential issues facing the united states and the world today, the ongoing trade conflict with china and china's changing role in the international financial system. china's evolving role in global trade is helping every corner of the united states economy. in my home state of nebraska which i tend to think of as being as far away as possible as you can get from all of this in
d.c., they suffered close to $1 billion in economic damage that's been attributed to the ongoing trade conflict with china alone. so this issue is wide-ranging, very complicated and incredibly consequential to the united states today. thankfully, we are about to hear from someone who knows far more about this issue than i do. dr. john lipsky is a fellow of the foreign policy institute. he served as first deputy managing director of the international monetary fund. from 2006 to 2011. previously, he served as vice chairman at jpmorgan investment bank and chief economist at several leading financial institutions including chase manhattan bank and solomon brothers. currently he serves on the executive committee of the national bureau of economic research and on the advisory board of the stanford institute for economic policy research. he holds a ph.d. in economics from stanford university and is a life member of the council of foreign relations. please join me in welcoming dr.
lipsky to the podium this evening. [ applause ] >> thanks for that very nice welcome. now let's see. if i stand up straight, can you hear me? the mic works. good. occasionally that doesn't work. thanks for coming. suffice to say this talk this afternoon is based on one that i gave, an updating of a talk i gave in january at chinese university of hong kong at the invitation of terrence chong, executive director of the institute of global economics and finance, and larry lau, former director of chinese university. i'm going to admit to having made for today a kind of rookie error. i've got too much material, too many slides for the time allotted so we are going to go pretty fast but you will find that i have on purpose used
materials from recent basically or almost exclusively used graphic materials from recent imf publications, first because they have done very good work analyzing especially the financial sector in china and its challenges and also that this material is easily accessible to all of you and i highly recommend you take a look at the recent work they have done accessible on the imf website, imf.org. basically, we will have three broad topics. first we will talk about the recent developments of chinese financial markets in the context of the broad development of the chinese economy. secondly, i'm going to talk about both the foreign participation to date in chinese financial markets and the reverse, china's participation
in international markets, and then we are going to talk about the prospects as affected by trade conflicts and the interaction that i see between the development of trade relations and the recent trade talks under way, notably between the u.s. and china but also other countries, and the development and role of china's financial sector and china's participation in international financial markets. so away we go. first, let's take a look at a few salient points. here's something that's well known. china's savings rate. here you see for 2017, china against a bunch of other countries, you don't have to look closely. that red bar is china. next to it is singapore, where there's forced savings, really, through the pension system, but
you can see the china savings rate is just exceptional within the world. why? well, essentially a reflection of policy, one of a long-term policy of first a repressed financial system that offered very, for many years, extremely low returns to financial savings and second, a very limited social safety net, so households especially felt the need to save in exceptional amounts. in addition, when we look to the development by sector, we can see that savings rate over time from '92 to 2016, red is households, yellow are non-financial firms, and the rest you can see hardly matters. so the point being that households relied on their own
savings for their own social safety net, if you will, for their own purposes, and businesses retained earnings for their own, to fund their own investment. hence these really exceptional savings rates. but here's something interesting. here we're looking now at household savings rate over time, and this is all the way from 1955 to 2015. this may be a surprise. in other words, that the success or the period of rapid growth of the chinese economy and development of the financial sector in china was actually associated with rising household savings rates, not the reverse. what you found is as incomes rose, that households felt compelled to save an even higher
proportion of their income than they did previously. so you can see even this runs through 2015, you can see even in the most -- in the post-crisis period that household savings rate has remained extremely high. well, there was another fact of the post-crisis period in the chinese economy, one that i think is well known to everybody who's paid attention and that is one of the ways that china sustained and restored growth after the onset of the global financial crisis of 2007, '08 and '09, was through massive stimulus, especially expressed through the growth in credit. here, we can see, if you can see this, that the red bars are the growth rates in credit. the green bars are the growth rates in output. so if you can see that closely,
as we know, in 2008 there was a substantial slowdown in growth met by huge acceleration in credit growth, those red bars. that blue line shows you the credit intensity. in other words, the amount of credit necessary to produce growth in gdp changed dramatically in that you saw credit growing explosively not only in absolute terms but relative to real growth. so there was restoration of real growth but in a context of credit growth that clearly seemed unsustainable. what was the nature of the problem. well, there was a lending boom to local governments to finance investment in local infrastructu infrastructure, corporations to finance activity and to
households especially to finance purchase of real estate. in addition, this also was associated with increasing complexity of the financial system in that previously, the financial system had been dominated by a few large state banks, banks whose original source was more like credit allocation operations in a state dominated or socialized economy, and were converting slowly into something that looked more like banks, but typically, they operated by offering very low returns on deposits and then were able to provide cheap credit to particularly state-owned enterprises that in essence were an implicit subsidy being provided by households. naturally, households and others wanted to try and get away from
that trap and they started developing so-called shadow banking or non-bank financial institutions or mechanisms, and what we found was they were growing quite rapidly because they offered so-called wealth management products that offered higher interest rates to private savers and hence, were in great demand. and not surprisingly, if you ask where did these non-bank institutions get the capital or get the funds, the liquidity to on lend, the answer was in many cases from the banks themselves that found those were more profitable than to on lend to corporations or especially state-owned enterprises. so here was this rapid growth of credit in an uncertain institutional context which the most rapid growth was in the form of non-tradition --
non-bank institutions and untested wealth management products that offered or created the uncertainty about the role of public guarantees. for those who know of china's financial history, where the credit crisis in the banking system in the '90s, that essentially those bad debts were socialized and so the question, the open question remained what was state guaranteed, what was not state guaranteed. so what were the principal challenges coming out that were seen quite clearly by the chinese authorities as well as others in the wake of the financial crisis in which it was the rate of growth was successfully restored but as i said, it is obvious in a context it was unsustainable as it stood. so here were the principal challenges. as seen by the chinese authorities, they needed to slow
credit growth while supporting sector rebalancing away from investment and toward consumption. they needed a wish to restore the role of commercial banks in restricting growth of non-financial banking institutions whose role in the system was uncertain. and they needed to accommodate rapid growth in the newly created local government bond market. these reforms or these need for reforms were recognized quite clearly in the plan that was promulgated in 2016, recognizing the unsustainability of the current circumstances. and one of the reforms of the post-crisis, post-financial crisis era was the requirement that local governments make use of these newly created local
government bond instruments instead of bank credit for financing their own operations, the idea being it should be much more transparent and controlled and controllable. the goals of this -- of the reform associated with the plan were enhanced transparency of the system, enhanced stability of the system, and increased efficiency of the system. and it wasn't just words. there were specific policy measures that were created to produce the desired results. in broad terms, the idea was enhance the systemic risk monitoring of the system, that there needed to be greater inner agency cooperation among the regulatory and supervisory institutions in china, that there was a clear need for increased bank capital, that
institutions needed to create much greater liquidity buffers, and there needed to be much greater clarity regarding potential crisis management. so all of these reforms, the point is a very simple one. it was clearly recognized not only by other observers but the chinese authorities, that changes of importance were needed. they were recognized in basic documents and given form in specific measures. particular importance was the creation of, in 2017, of the financial stability and development committee which essentially is a committee that, quite a bit like the macro credential committees created in the u.s. and the uk and others in the wake of the financial crisis to make sure this involves the head -- the people
of the central bank, minister of finance, et cetera, all the most senior economic and financial officials are members of this committee that is required to oversee the stability of the -- and the development of the financial sector. the system had become complex and uncertain and needed clarity but also, an aspect of the desired reforms were an opening up of the financial system to international participation. so all of these were taken in the context of the post-crisis era. so let's take a look and see what happened. if you can see, again hopefully, you don't have to read the details. i'll explain the graphs and they
should be quite clear. what you see on the left side is what happened to the credit growth in the post-2017 period. blue, wealth management products. those, that's the shadow banking system. growth rate slowing very sharply. red line, inter-bank claims, one of the ways the shadow banking system got financed, slowing sharply. green line there on the left, total social financing, growth rate slowed sharply. on the right, bank assets, now we're looking at traditional bank assets as a percent of gdp. sorry, first the blue line on the right is the growth rate of bank assets. so you can see a very sharp slowdown. on the right, the total of bank assets as a percent of gdp. you can see that rapid growth
and the slowing. by the way, perhaps you can't see the numbers, but total bank credit, total bank assets as a percent of gdp in china reached nearly 300% of gdp. in other words, far in excess of any other banking system in the world. okay. the shift, the desired sectoral shift, remember, slowing credit, slowing credit particularly from the non-bank or the shadow banking system, and supporting a
rebalancing of the economy away from investment and toward consumption. well, it turns out that this tightening that was accomplished through various means, including regulatory tightening, really hit the shadow bank credit expansion from the smallest banks. on the left you see the net increase in credit from the biggest banks and on the right, from small and medium banks. what this graph shows again, you don't have to read the details, on the left, there was a slowing but continued increase in the growth in credit from the largest banks and on the right, you can see there's an actual decline in shadow banking credit from the smaller institutions. so that had an effect. but it also meant that it hit
particularly weaker borrowers. here, what you can see is this is 2014, '15, '16, '17 and '18. those bars show you the amount of defaulted debt. the green line shows you the yield spreads between lower -- between low credit private banking -- private bonds, and base government bonds, central government bonds. so you can see the yield spread increased, in other words, the cost of credit to weaker borrowers relative to government debt expanded, so credit became relatively more costly for weaker borrowers, and there was a substantial increase in bond defaults. so this has produced a winnowing out of weaker credit.
but it also meant that bank assets which i already told you are at a -- not only particular highs but higher than anyplace else in the world relative to gdp, are still growing. so here, we can see on the left side the total capitalization of the bond market in china, that blue line, so you can see it levelling out as we get to 2015, '16, '17. the red line shows you bank assets. they have leveled out and stock market capitalization actually came down. if we look on the right-hand side, we can see as a percent of global gdp, by the way, that means that chinese and the red line, using the right hand scale, the left hand scale is for bond capitalization, stock
market capitalization. hopefully in the back, you can see the numbers. chinese bank assets as a percentage of world gdp, 50%. bond market capitalization, stock market capitalization, 8% to 10%. so it gives you an idea of the scale of what has happened to bank credit in china. so has this slowdown produced all the effects that was intended. for one, we can see here that green bar shows you net borrowing from wealth management products. in other words, from the shadow banking system, they have continued to grow. they did not stop.
and this red line shows you here, bank lending to wealth management products has also continued. so it hasn't been stopped. and when we look at who is doing the borrowing, what you can see essentially is here, infrastructure and property firms, other non-financial firms and retail. so you can see that the decline over here for property and infrastructure is much less than for the other sectors. and here, you can see again that there's continued credit growth from non-banks to -- from the shadow banking system to the
property infrastructure, other forms declining. so exactly the forms, the area that was -- that they wanted to cool down is continuing to grow, property and infrastructure. why that is a bit worrisome, you can see the leverage of the infrastructure and property firms versus other non-financial firms, so the firms that are the most levered are continuing to get the most credit. and when we look at the stability and solidity of the finances of these firms, this shows you the measure called debt at risk which is the share of the debt outstanding in which the borrowers' income is less
than their debt service payments, their interest payments. here we have infrastructure firms in the latest data, about 25% are not -- are at risk in the sense their current cash flow is less than their current debt obligations. these are the firms that tend to need to borrow to pay their own debt. so this is -- these are infrastructure and property firms and these are other non-financial firms. so progress, but, and the but is you can see that the weakest sectors are still getting more credit. and despite the slower credit growth, that means the leverage is still rising for the economy as a whole. here is corporate, government and household debt as a
percentage of gdp and here we have household leverage, corporate leverage is still rising. so this has only been partially successful. secondly, as we all know, there has been associated with a slowdown in overall growth in china that reflected, among other things, a slowdown in -- at the end of last year in sectors like auto purchases and others, so some forms of household consumption spending have slowed substantially. corporate investment, private businesses, also slowed because it turns out that they were -- that the shadow banking, non-bank financial sector, is the principal source of credit to private firms, whereas the
traditional state banks continue to be the principal source of lending for state-owned enterprises. and that means that state-owned enterprises are still investing even though here we have return on assets for private enterprise, state-owned enterprises. the state-owned enterprises as a whole are much less productive but their assets continue to rise and that means that the, in essence, a problem that has appeared in the chinese economy despite the restored growth in the post-crisis period, that despite investment rates that also like savings rate have been higher than anywhere else in the world of investment to gdp of nearly 50%, that the growth in productivity has only been about
average in recent years for emerging markets. another sign of the need for reform. so despite the efforts so far, as you can see, you are still having problems in terms of sectoral use of credit. and that's as a result, it's not so surprising that the switch sectoral shift toward consumption and away from investment in china has actually been progressing, but progressing quite slowly. here, you can see a scatter diagram. this shows percentage, capital formation as a percent of gdp here and consumption as a percent of gdp here. these are country observations. this is china in 2011 and that's china in 2016. so has there been progress in
the sense of less investment, more consumption, the answer is yes, absolutely. but china is still in a different category than any other country, any other large economy, any other economy, sorry. and there's still a problem, residual problem that is hinted at by the amount of leverage that debt at risk chart i showed you, and that is the persistence of so-called zombie companies. zombie companies that are not profitable, are not conceivably profitable, who are producing negative return on assets, as a result have ceased to be able to invest, yet whose leverage continues to increase because they persistently require new borrowing to cover old debts. so in essence, it's a kind of
ponzi scheme, unless they can make improvements in their underlying behavior. but this has been a persistent problem in the chinese sector. one that has been addressed in terms of the number of firms that can be qualified as zombie firms in this condition but in fact, the amount of credit that they are absorbing remains non-trivial. so this is another problem that hasn't been completely resolved. so big picture, there have been some -- a recognition of the problem, there have been important efforts both in terms of policy and in terms of structure creating new administrative structures, new authorities, et cetera, that are producing results, but have far
from resolving the strains in the financial system. long way to go. now, i wanted to point out next part of the financial system is how important the growth in the local government bond market has been to the chinese financial sector and you'll understand the implications. here is the size of fixed income markets in u.s. dollars. that's the u.s. that's the u.s. bond market. bigger than anybody else's. here's japan, that's second. here's china in 2013. here's china in 2017. so there's been huge growth relative growth in bond issuance in china in just the post-crisis
period, essentially driven by the explosive growth of the local government bond market. so china now has essentially call it the third largest bond market in the world, probably going to pass that of japan soon. and here's the growth, you can see year on year growth, this is in percent of gdp. here's the central government bond market. here's the local government bond market. huge shift in financing away from bank borrowing and other forms of borrowing towards these local government bonds. and this debt is used to finance construction and infrastructure. here you can see social housing, construction, land development, essentially that's what these expenditure is going for. and there's been a huge growth,
as you can see, here's just another way of showing you, here's the sovereign bond market, pie chart of the whole, here's the local government -- local government bond market. here's corporate bonds. so increasingly important, another aspect of the chinese, one of the positive aspects is despite all this, because of the savings rate of the household is so high, that the debt ratios of households is relatively low, and here's an international comparison of household debt as a percentage of gdp. it's still relatively modest as the other forms have grown. okay. so that's a snapshot of the
situation in the chinese financial market. again, to recap, big challenges, structural challenges that became acute in the wake of the financial crisis in which there was success in restoring growth but in a way that is financially unsustainable. the reaction that was encompassed in the five-year plan in an attempt to strengthen the underpinnings of the system to make it more transparent, clear shift back to the -- towards the commercial banks, traditional state-owned banks, and through the creation of the local government bond market, a huge change in the structure of the system but one that enhanced transparency and hopefully efficiency. but at the same time, you saw that it was far from having
solved the problems that were evident in terms of the degree of leverage and that the highly levered sectors are still getting more credit. this hasn't been resolved. now i want to turn to the second part of my presentation which is about china's role in international markets. we are going through this quickly but all of these themes could have been the topic of a whole talk. here's the point. simple point. which is despite this huge growth in the chinese financial market, foreign participation remains extremely small. and at the same time, despite the presence of, and the awareness of chinese investment abroad, china's participation in international financial markets remains quite limited so far. in ways that are probably going
to surprise you. okay. so we already said china's bond market is internationally significant. here's the u.s. again, here's the whole euro area put together. but of course, there's no euro bond, euro area bond. those are all sovereign bonds. these are just denominated bills. there's a series of sovereign bonds from the euro area, japan, china. okay. but what is the foreign participation in china's stock and bond market. here we have them as a percentage of the market size. this is from 2012 or sorry, 2013 to 2017. here we have the bond market, stock market percentages around 1.5% of the total market. so foreign participation in
these markets is i won't say trivial, but let's be generous and say minimal. there's very little. and this is unusual even for the region. here we have on the left stock market, bond market. here's as a guide, foreign participation in the u.s. stock market about one-third, u.s. bond market, about one-fourth, foreign ownership, and here we have, and this is comparison with the region, here in the stock market, that's korea, bond market much less, this is japan, 16% in the stock market, so 10% in the bond market, then we go down, here's china. so you can see by comparison even within the region, foreign participation in the chinese domestic market is essentially, i hesitate to use the word trivial but minimal.
when we look at the foreign direct investment, what we are finding out is some developments that i think many people haven't been aware of and that is -- i'm doing this a little bit backwards. service restrictions on service sector entry is relatively difficult. in other words, here is the oecd has a measure of the restrictiveness of entry of foreign firms in the service sector. that's china. higher means more restrictive. lower means less restrictive. this is the average for the oecd countries, that's the average for emerging markets, that's china. this is a similar measure of regulatory restrictiveness, same measures, point very simple. china is unusually restrictive on ability of foreign firms to
participate in service sector. guess what's happened on the manufacturing sector? fdi has tended to go into export oriented manufacturing and china has lost competitiveness in this area. so perhaps surprising to most people, here's what's happened to fdi into china. it's actually been slowing substantially. now this marks the 75th quartile range into emerging markets. fdi in relative terms in china is actually very low for emerging markets, not very high, because that export oriented manufacturing fdi is going to vietnam, going to indonesia, is not going to china. so it will take changes to get great
greater, as we saw, greater openness in the service sector, greater competitiveness in the manufacturing and export sector to reattract fdi. and let's flip it around the other way. what about chinese participation in foreign securities markets? here, we have the international investment position of china, here are liabilities and assets. here's the u.s., japan, korea, india, china. point being that chinese participation in foreign markets is quite limited in percent of gdp relative to their gdp. so these are again, china, despite the publicity, in fact is a relatively small player in foreign financial markets.
here's an area you may find surprising. first let's look at trade linkages. this graph is imf developed to show actually this is trade as a percent of gdp. trade as not a percent of total trade with china, not trade with china as a percent of total trade, but trade with china as a percent of these countries' gdp. so you can see that there's the commodity exporters, here are some in africa, but even countries like brazil and argentina, commodity exporters that have very important trade ties to china actually as a percent of their gdp is not particularly great because those are relatively closed economies. brazil is not a very -- it's a big exporter but the exports relative to brazilian gdp aren't
that big. nonetheless, here's the point, that china has both broad and significant trade linkages, probably a little smaller when characterized in terms of gdp than you might have thought but here's the main point. now, if we look at those in terms of bank linkages, if you can see the color coding, it's really relatively restricted to just a small number of relatively small economies, and that is probably a number that is probably surprising to most people. despite the efforts to internationalize the chinese currency and promote it, for example, as a measure of -- or as a vehicle for financing trade, that actually the use of the rmb in settling their own chinese trade has fallen from
about 35% in 2015 to about 20% currently. in other words, the use of the rmb even in clearing china's own trade has receded recently, not the other way around. so once again, there's a long way to go. but where should we be going? well, this is a simple one. share of gdp appear their growth in gdp should create a natural prospect for an increasing role in international markets and they have announced a series, despite the skepticism and perhaps you have seen some publicity from some, even right around this neighborhood in washington, of folks saying that there's been a big retreat from international openness and a refocus on state enterprises and
away from market reform in china. in fact, at the recent national development forum in beijing and as expressed here at sais by my former imf colleague, gave us a whole list of new market opening measures that china is undertaking with the notion that they are, among other things, permitting foreign majority ownership of domestic financial firms, something that was not permitted before. with the idea that there's a prospect of relatively rapid expansion of the so far minimal role of foreign firms in the chinese market, but it has been pointed out that it's not just ownership that has restricted their role, but also regulatory
and supervisory issues and it's not clear whether those are going to be relaxed at the same time or at the same speed that the ownership rules are being relaxed. so this remains uncertain even though it seems like a natural, if there is going to be continued market orientation in china's economic reforms. but what we have seen as i described that surprising result for most, the decline in the use of the chinese currency for settling china's own trade deals, that it was instability and volatility in markets in late 2015 and '16 in which the rmb fell in value in international markets, that instability, volatility and
policy uncertainty certainly would inhibit china's progress and it seems clear, trade conflicts are a direct way of influencing, for better or for worse, both market volatility and policy uncertainty. in other words, what i'm trying to say is something quite simple. that progress in trade is going to be critical for the growing or shrinking international role of foreign financial institutions in japan, in china, or chinese institutions in the rest of the world. that slip for using japan is because there are many parallels between, if you remember back in japan's rapid growth period and the expansion of japanese financial firms around the world
and their subsequent crisis and the shrinkage of those firms from international markets, so it's not inevitable that the progress in a desired way, but it seems clear opening a global market to china was key for their unprecedented growth in the 1990s and 2000s, that it was international cooperation that helped to stop the global financial crisis in 2007, '08 and '09 but cooperation implies compromise, implies reaching agreement on fundamental principles and on operational details. so that is going to be required to produce new progress. we all know that there are important negotiations under way. i don't have to -- you can read about them every day in the
newspaper. what you don't know is how much progress is being made. we know that the important issues are around intellectual property, protection of intellectual property, technology transfers, the role of official subsidies in things like the china 2025 program, cybersecurity issues. we can all read about those every day. and as we know, as we speak, there's a summit meeting on belt and road initiative under way in beijing right now, and there's controversy and uncertainty about how to interpret belt and road in terms exactly of is this a means of increased openness and engagement or is it a measure of greater state control and less openness.
we will see. there are reasons to hope for progress, obviously. china is adopting a new foreign investment law that was going to provide, again, much greater openness in terms of access to sectors in terms of technology transfer, et cetera. so there's hope in that regard. both the u.s. and eu have announced new investment review processes that were viewed as restrictive but in fact, could at least clarify rules and lead to greater certainty. and of course, we have the trade negotiations not just between the u.s. and china but elsewhere. so there is prospect for progress. but there's a deep long-term issue that has to be addressed, and that is if the future of chinese economy is socialism with chinese characteristics, if
the chinese economy is going to be in its structure different than that of the oecd, of oecd market-oriented economies, how will china in the long term fit into the international trade and finance system? here potentially the role of the wto is crucial. there are three options. either we come up with new rules in which we can agree, define a level playing field for both the chinese economy and their trading partners that everyone accepts as fair. that could come through a new treaty. but those don't look very plausible, which is why the u.s. and others attempted to approach these issues through either
mega-regional or plurilateral trade negotiations like tpp with asia and ttip with europe. the idea was to negotiate to renew the doha round with all the members of the wto was too complex. it was never going to succeed. but if we could come to kind of an agreement among smaller groups of countries that were still -- were very important, that that would promulgate and create, implicit ly create the basis for standards. but there are aspects of the chinese economy that are likely to be with us for a long time that are simply not like the normal, like normal market economies as we think about them. the state enterprises which in china report up to the state
sasac, which is the state asset control administration commission, which is essentially a holding company for the state enterprises, has no counterpart elsewhere. the large state banks are controlled by an organization called the central region that was formed in the wake of the crisis in 2003 as a way to control the banking system. there's no equivalent in other oecd countries. there's the national, the ndrc, the national development commission that controls not only planning, but also the energy sector, pricing, et cetera, that has no counterpart in oecd countries. so ultimately, if that, if china, if the structure of the
chinese economy is going to retain chinese characteristics, then eventually there has to be an agreement if we're going to have an open, fluid trading system on rules of the game that are seen as fair by both sides, fair and sustainable in the long run. what's uncertain is whether that's going to be the goal of the current negotiations under way. there's another aspect of particular relevance to the financial system and that is the reform efforts under the auspices of the g-20's financial stability board. so far, you would say that global markets are probably still more fragmented post-financial crisis than they were before the financial crisis. so once again, china's role is going to depend to some degree in the international markets on
how reform in the international markets continues. there are big unknown issues such as will there be completion of a banking union in europe. in the euro zone. will there be a capital markets union. how will chinese markets develop with regard to their regulatory reform. all these are open questions. but i come back to -- and end on the simple point that most progress was made in the context of cooperation and openness, and preserving a sense of open markets and compromise holds open the prospect that should be natural for an expanding role for china in international financial markets, but for the
near term, it can't be taken for granted. it has to be achieved through specific agreement and progress. i'll stop there. thank you. [ applause ] >> thank you for your remarks today, dr. lipsky. before i open it up, i would like to capitalize on my position and ask you one quick question. there are rumblings lately that china may be facing a financial crisis in the near future. if china were to face a financial crisis, say in the next five or ten years, what form do you think that might take and what would the implications be for the international financial system as a whole? >> well, i think the dangers of stability for the chinese financial system are fairly straightforward. one, we have had very rapid growth in the housing market and
with uncertain underpinnings, there are those who claim there's a risk of a housing bubble and that a downturn would have very broad-ranging effects on consumption and on household finances. and confidence in general. secondly, there's been huge infrastructure spending, uncertainty about the economics, the financial soundness of the very large growth in the debt of public enterprises such as the transportation sector, for example, high speed rail, huge expansion and rapid pace, will they be able to finance the debts or pay the debts that were used to finance them. so there are some challenges going forward. and even though as i described in my -- i mentioned in my
remar remarks, the need for greater clarity about crisis resolution, if there were to be problems and crisis management if there were to be problems is still uncertainty. so the risks are visible. the severity is unknown. and hopefully the kind of progress and recognition that the authorities have had toward the need for progress and the specific measures they put forward will end up avoiding any kind of severe moment that would obviously be bad for china and bad for china's trading partners. >> i would like to ask you one more. is my mic on? i would like to ask you one more question about shadow banking in china. so compared to the united states and some other western countries, china's shadow banking sector is still
relatively small. why are authorities so concerned about staunching the flow of, you know, sources of shadow credit to private firms? >> well, i think the source of concern were quite straightforward. there was a lack evof transparency, uncertainty about the regulatory environment and the stability of the sector. so a desire to put more order and that was expressed as a desire to slow down credit in the non-bank sector and return growth to the conventional commercial banking sector. what we saw was the problem that it was the private firms that were the most reliant on non-bank financing. so that slowdown in the growth of that credit was associated with the worries about the
continued growth of the economy. produced, among other things, an admonition by the authorities to the commercial banks, traditional commercial banks, to increase lending to the private sector. but in fact, those institutions don't have a deep history of credit analysis. they were more used to shoveling credit to the state enterprises with less concern about their creditworthiness. so it's a need for development of more agile and a more orderly financial system, but probably a more complete financial system with much more richness in terms of instruments and institutions. >> all right. thank you. with that, i will go ahead and open it up to the floor for any questions or comments. we will start here. >> from george mason university.
two comments were made at the imf spring meetings. i will ask your thoughts on one that the trade dispute with the u.s. is a strategic gift to china in the sense that it will induce some of these changes that might not otherwise have occurred, and the second comment is that had china, if china actually was a more open financial and more integrated to the global financial economy, that it would contribute to more volatility, it would make the global economy more volatile rather than stable. just wanted your comments on those two points. >> yes, thank you. good questions. certainly, there was a growing sense of frustration about trade rules between china and its
especially developed economy partners that needed addressing. so the fact that there is a negotiation going on is potentially positive. the problem is, of course, it's happening on piecemeal basis rather than multilateral basis. and stability will require a broad agreement that whatever rules or whatever agreements are reached are generally fair, and of course, if the concern is that one or another partner such as the u.s. merely concerned about bilateral imbalances reaches an agreement that is essentially china agrees to buy more of this and more of that, that sounds like trade diversion rather than trade creation. that sounds too much like taking some away from -- trade from some place and moving it here, which is not a good way to create a system that is stable,
viewed as stable and fair by all sides. so the deeper questions need to be addressed. they will be complex and will take time. but your question is if there is success and greater integration, that it would increase volatility. it seems right now the story that i think it was implicit was both domestically in china and elsewhere in world markets, there's a sense of suppression of pressures that if not resolved, would lead to greater volatility. in other words, it's the failure to reach agreement in these areas that would contribute to both the threat of volatility and ultimately, volatility itself. in other words, if there's a sense of lack of fairness, lack of openness, lack of effective and efficient integration, that
strikes me as a source of concern rather than the opposite. >> i used to teach [ inaudible ]. two questions for john. you put your slides on, it's too much information to absorb. my question i really wanted to put to you concerns the first part of your presentation and it's really to ask you to elaborate on the moderator's first question, china's vulnerability. listening to you and looking at the slides to the extent i could absorb it, it's hard to avoid the impression that vulnerabilities are building up in the system left, right and center. the overall debt efficiency of gdp growth, the leverage ratio,
even the household leverage gdp ratio which is now over 100% according to one of the slides you showed, it's frightening. what are the main points of vulnerability? what events could trigger crisis or bad things happening? in particular, could you elaborate on the vulnerability of the financial system in relation to real estate markets where a lot of the borrowed capital seems to be tied up? >> yeah. thank you. first, thank you for your remarks. thank you for coming. i plead guilty to too much information. which is why first of all, the slides will be available, but also, they almost entirely come from the recent imf publications exactly so to encourage those who haven't, to take a look and
peruse them at your leisure. they are very easily available and of course, open the way to more detail on almost every point. jumping ahead, what would the trigger be for a crisis. it seems easy to say, housing bubble. there's been an assumption, there is uncertainty but agreement that there's a large stock, non-trivial stock of housing, apartments, basically, that have been purchased for investment purposes under the assumption the prices, the purchase prices assume -- or assume capital gains. this is not the first time this has ever happened in a housing market. what's unknown is the degree of vulnerability. but the numbers suggest that if there were a turn in the market, it would be non-trivial.
and it could have broad effects. how it would be resolved, if, if such a thing were to occur, of course, would depend on policy. would the solution be to try to keep the credit institutions whole or would they be forced to write down their debts. and would the households be protected in any way from their indebtedness. those are still, i would say, open questions for which there's no clear answer, in part because the degree of the problem, potential problem, is uncertain. but the most likely problems would be -- seem to be from the housing sector.
but also, local governments and those who invested in infrastructure as i showed you are relatively highly levered and many of them have very poor debt service coverage. so would be vulnerable as well in a downturn. >> right here. >> i have two questions. one pertains maybe more to the united states but it certainly involves china. that is, do you think it was a smart move or do you think it was a mistake when we withdrew, the president withdrew from the tpp, and my second question is that i read an article not too long ago about china's belt and road initiative that indicated that they could ill afford the
growth and magnitude of it. i wanted to get your opinion on that issue as well. >> sure. first on tpp. good question. i would say the answer is we'll have to see. the idea of tpp was it was kind of an odd collection of countri countries, had japan in, china not in, korea not in, india not in, so the big idea was let's get the folks that are willing and able to agree, a non-trivial group of countries because they include japan, that would agree on some principles of a trade agreement standards, and that that would provide an important incentive for the others in the region to join and if they did
join, there would be the starting point for negotiations was -- would be well, we already have an agreement. you want to fit into that agreement. that always strikes me as even though this was not ideal and the selection of countries, it left out korea, et cetera, was way short of what you would have wanted, but is it better than nothing, we'll find out. my own personal view is that it's much harder to negotiate these things on a bilateral basis because if there's agreement, it means if i make a compromise, i'm giving up to you and you're giving up to me, it's very exposed politically, so it means i can say well, look at the wonderful things i won and the critics are going to say but look at all the wonderful things you gave away, you weakling. it makes those things very hard, especially because they tend to
be very complicated. that's why it's better to approach it, in my view, you can understand why to negotiate on 130 countries for doha gets very complicated but if it's a smaller number of very powerful countries, then we get to say, everybody gets to say yes, everybody got some, everybody gave some, and we all did it together in the interest of making the whole system work better. that always strikes me as politically more feasible than saying you and i are going to get up in public and solve this, the two of us together. i think it's very difficult. i would be very happy if these u.s./china negotiations produce the kind of underlying agreement on principles that are necessary to create a sense of fairness all the way around, but even if the u.s. and china agree, then what about everybody else. if i can use the moment, the really powerful agreement that
would have happened that didn't happen that no one talks about is ttip, the trans-atlantic trade and investment partnership. if you had gotten the eu and the u.s. to agree on a set of standards, that would have been immensely powerful. but you just couldn't get frankly the europeans weren't willing to make the compromises necessary, the u.s. wasn't willing, so nothing happened and we are now left with these renewed eu/u.s. negotiations not clear where they're getting. your second part was? >> [ inaudible ]. >> oh, belt and road, thank you. yes, as you can see, there is -- it's a big topic.
belt and road, the g-20 leader summit in melbourne three years ago, melbourne, australia, focused on international public infrastructure, created an infrastructure information clearing hub. the idea was there would be a cooperative approach to international infrastructure. then along comes belt and road and -- which seemed to have been created whole cloth outside the g-20 construct. i think that a lot of the pushback that you see comes from the fact that it was promulgated by china, not by -- not as a cooperative effort, and now there's an effort on to make it very much more cooperative, coherent and acceptable all the
way around. obviously good, well-designed international public infrastructure can be, if it's well done, very useful and supportive of development and very useful for -- especially for some of the emerging market beneficiaries of the belt and road initiative. but there are issues of debt transparency, of the planning process, whether procurement is going to be seen as fair and open internationally. there are a lot of issues that are still uncertain about belt and road. >> [ inaudible ].
>> well, i think the belt and road initiative, it's very large in broad design. much of it i think is schematic rather than highly detailed at this point so i think it's a matter of let's see how it turns out. ... it results in agreement on greater debt transparency, roles of procurement, etc. could be very possible. >> we have time for one question. >> thank you for the presentation. , first-year student and i have a question about china's financial system. there has been tentative measures made in order to open up china's financial recovery.
still very uncertain what this would look like in the future. i just want to hear your opinion on how this impacts the banking system and especially their banking system. there would be complicating the source in china. >> yes. if the question -- i think i understood but to make sure, the issue is really right now, they will be closed in china, the ability of chinese citizens to acquire foreign assets is limited which is one of the reasons why china's participation is relatively small.
if there was nothing, we have experience with that on the u.s. japan in the 1980s. when there was an opening of the japanese capital account and japanese investment firms were suddenly allowed to acquire foreign assets and at virtually any amount. one of the factors that produced the so-called super dollars and the 84 and 85 that was disturbing, it led to the formation to the so-called as a group of five which became a group of seven. this has to be in the capital and done carefully to avoid disruption. however, it seems to me that the careful opening of the capital account including participation of foreign financial firms in the market is the quickest, best
and most effective way to make a domestic financial markets more efficient and effective. over time for sure, in the market, you have to presume that chinese investors are going to want to diversify the portfolio internationally. now they're doing it in many cases apparently through typical matters exported over invoicing work requiring foreign real estate apartments, etc. as a form of financial investment abroad but if the accounts, if the capital account were more open in an orderly way and if the financial drastic financial sector was allowed to develop in a more complete and fluid way,
these would be much less disruptive and threatening. hopefully as we heard, there have been certainty, an important potentially important change of allowing foreign financial firms to acquire majority interest and domestic securities markets. that suggests the possibility of bringing the latest technology, the most efficiency and richness of both maturities and instruments to the domestic market. let's say that's actually about to happen, if that happens, opening of the capital account, i think it would be an economic efficiency, stability in china.
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