FUTURES MARKETS FOR CHINA

China Council for the Promotion of International Trade (CCPIT)
September 2004
Beijing, China

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We stand at the dawn of the Twenty First Century. Admittedly, the geopolitical landscape is laden with terrible strife, controversy and danger. Similarly, there exists the specter of economic difficulties within many regions of the world. Nevertheless, the Twenty First Century represents unlimited opportunities and that is especially true for China and East Asia.

Today, nearly every country on the planet has a market-oriented economic system and is attempting to be a competitor in the global marketplace. For the past 20 years when we spoke of a global economy, we were talking about only 25% of mankindmostly North America, Western Europe, and Japan. Suddenly, there are three billion more participants in the global economic system.

For centuries China stood as a leading civilization in culture and science. Then came the political upheavals and internal problems of the 19th and early 20th centuries that brought a virtual halt to its history of progress. However, in 1978, the new government under Deng Xiaoping introduced market reforms with an eye toward a market economy. The result: China again became the world’s growth leader with an output that quadrupled in the last two decades.

Thus, China is making the transformation from a communist centrally-planned economy into what authors John Wong & Lu Ding of the National University of Singapore, call a "socialist market economy," which increasingly embraces free markets principles. As they point out, within a few short years it became the workshop of the world. I want to take this opportunity on behalf of the Chicago Mercantile Exchange to publicly congratulate President Hu Jintao and wish him luck in continuing the path on which China is successfully pursuing. The rapid growth has strengthened China’s economic power and begun the process of raising the standard of living for its people. Make it in China and export it back to the rest of the world is now a predominant business strategy. Foreign-affiliated companies now account for half of China’s exports of manufactured goods. Indeed, direct foreign investment into China has become the world’s major trend, putting America in second place for the first time. That is a dramatic metamorphosis.

However, continued growth will not be without pain. China’s markets are still a long way from embracing all the tenants of the free market. Major structural problems remain. Learning how to maximize the benefits of globalization, while minimizing internal disruptions will be a formidable challenge for policy makers. As China embraces the World Trade Organization and becomes integrated into the world economy, it urgently needs to improve the domestic business environment and to strengthen indigenous industries. While Chinese companies are entrepreneurial, flexible and focused on profitability, they need the financial tools to manage capital more efficiently.

Today, the largest difference between rich and poor countries—between economic hope and economic despair for its people—is the freedom and efficiency with which they can utilize their resources. Free and efficient capital markets ensure that resources are allocated wisely. The more efficient the system, the better the allocation of these resources. Efficient markets lead to greater market liquidity. A liquid market reflects truer price values and gives investors confidence in the marketplace. As a consequence, capital markets are strengthened, capital cost is reduced, and capital is utilized more efficiently. Ultimately, the standard of living is enhanced, and social order is greatly benefitted.

To manage modern financial risks, the marketplace has turned to financial derivatives. The economic function of these instruments is to provide a safety-net based on benchmark groupings of inherent business exposures or to unbundle the risks involved into their basic components and transfer them to those most able and willing to assume and manage each component. Consequently, financial derivatives—both on centralized futures and options exchanges or customized in the OTC market—can be likened to a gigantic insurance company that allows financial market risks to be adjusted quickly, more precisely, and at lower cost than is possible with any other financial procedure. It’s a process that has strengthened capital markets and improved national productively growth and standards of living.

Nobel Laureate, Merton Miller, once stated that the simple standard for judging whether a product increases social welfare is whether people were willing to pay their hard earned money for it. In other words, is the product being used. By that standard, financial futures products proved their worth a billion times over. They motivated the concept of financial engineering, engendered the era of OTC derivatives, and spawned financial futures exchanges in every corner of the globe—from Argentina to Australia, from Italy to India, from London to Kuala Lumpur and propelled the CME into first place in the world. Today, according to the BIS, outstanding notional value of Over the Counter derivatives as of December 2003 reached $197 trillion. Add to that the current value of open interest on centralized exchanges and you approach an outstanding notional total of approximately $240 trillion.

The reasons for this phenomenal growth, especially during recent years is clear: The world has increasingly become but a single global market—a market within which information travels at Internet speed, within which competition is intense, where interest rates, exchange rates, and other asset values are volatile, and where dangers as well as opportunities, global, regional, or local, rapidly appear and disappear on an ever changing financial horizon.

We note that financial futures were developed at the CME in the wake of the breakdown of the Bretton Woods and its system of pegged exchange rates. Our market was an important factor in advancing the development of global markets. Which brings to mind the current discussion over a possible revaluation of the Chinese Renminbi. We are sympathetic to the fact that currency controls, capital controls, and export subsidies often serve a purpose during the formative stages in an emerging economy—but at some point, the economy must throw off such shackles in order to avoid impeding further development. That point is now. Accordingly, we urge the development of a financial derivatives market here that can assist in managing the risks attendant to an emerging and blossoming financial ecosystem. More to the point: The Chicago Mercantile Exchange stands ready to assist this process.

We applaud the National People’s Congress acknowledgment for the need for additional futures instruments. Under the direction of the China Securities Regulatory Commission there is now a reformed market structure with several important futures markets. These actions have given much needed encouragement to the growth of a modern futures market in China. It propelled the Chicago Mercantile Exchange, the largest futures market in the US, to execute an historic Memorandum of Understanding with the Shanghai Futures Exchange as well as with China Foreign Exchange Trade System (CFETS). These agreements will allow the CME to provide expertise and advice to their Chinese counterparts with a goal to ultimately create mechanisms for viable derivative markets in China.

It cannot be over-emphasized: Transformation in information technology created a world economy. Current political confrontations notwithstanding, it will continue to foster more globalization, greater interdependence, instantaneous informational flows, immediate recognition of financial risks and opportunities, continuous access to markets of choice, more sophisticated techniques, new innovations, and intensified competition. These are the unalterable trends of the Twenty First Century. The markets of China must embrace this paradigm.

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