Dawn in China
By Leo Melamed
October 24, 2006
you do not want done to yourself, do not do to others," so said
the great Confucius.
embrace that advice. We would not encourage the Chinese government
to embrace financial derivatives, if we ourselves did not embrace
them. We would not encourage the financial community of China
to develop financial derivatives instruments, if the financial
community in the U.S. and other industrialized nations did not
benefit from their development. What was true for the Chicago Mercantile
Exchange (CME ) is true for the exchanges in China today. In other
words, it is our unalterable opinion that development of financial
derivatives on futures exchanges should be the next step in China's
progression to develop strong, liquid, and efficient capital markets.
That accomplishment will benefit the people of China.
advice is fitting because we stand at the dawn of financial derivatives
markets in China. It is a momentous milestone, one that did not
occur by accident. It represents a link in a continuous chain
which transformed China from an agriculturally based, centrally-planned,
economy to one that is industrial and market-driven. The results
have been nothing short of astounding.
is today the world's fastest-growing large economy. The country
has grown around 9 percent a year for more than 25 years, the
fastest growth rate for a major economy in recorded history.
In that time span, China has moved from less than 2% world economic
output to nearly 7% of global output today. Since 1980 Chinese
exports have surged more than seven times, while global international
trade has merely doubled. China has achieved this export success
by attracting a large volume of foreign direct investment and
promoting total integration with the global economy. China is
now the world's third largest exporting nation after the U.S.
and Germany. At the current growth rates, China could become
the world's largest exporter in just three years.
questions come to mind: First, how was this made possible, and
second, what should be done to preserve the benefits to the Chinese
people, while diminishing the inherent risk that comes with such
fast growth? The answer to both questions is not difficult.
the transformation was built on the economic reforms that began
in 1978 with Deng Xiaoping and continued under the leadership
that followed through President Hu Jintao today. But China's
success is also the consequential result of information technology
which created a world economy—in a word, globalization.
A world of instant mass informational flows in total disregard
of internal prohibitions or national boundaries. A world where
nearly every country on the planet has a market-oriented economic
system and is a competitor to everyone else. A world with technology
so sophisticated that every idea can be swiftly tested and implemented.
A world where whatever can be done will soon be brought to the
marketplace by someone.
Zhou Xiaochuan of the People's Bank of China recently stated
Chinese growing trade surplus was primarily the result of cross-border
outsourcing and supply chain readjustment under the globalization
trend of recent years. The so-called cross-border outsourcing
refers to multinational companies moving part of service or production
abroad where labor cost, tax burdens and other burdens are lower.
As the trend of globalization gained ground, more and more multinational
companies have relocated production or services abroad, and included
the products as part of their global supply system to readjust
their supply chain. Quoting U.S. writer and columnist Thomas
Friedman, Governor Zhou stated cross-border outsourcing and supply
chain adjustment was the inevitable result of world economy moving
to adapt to globalization.
The Governor is exactly right. The more China opened up to the
global market, the more attractive it was in outsourcing. Thus,
China has attracted over $650 billion of foreign direct investment
(FDI) which now account for 51% of the country's trade surplus
compared to only 3% in 2000.
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. These are the unalterable trends
of the Twenty First Century, ones that cannot and will not stop.
More globalization, greater interdependence, greater cross-border
outsourcing, continuing supply chain adjustments, instantaneous
informational flows, immediate recognition of financial risks
and opportunities, continuous access to markets of choice, more
sophisticated techniques, new innovations, and intensified competition.
are those who would criticize this trend. They are in error.
It cannot be stopped nor should it. There are those who point
out the negatives of globalization. They are mistaken. Whatever
negatives are inherent in globalization, they are vastly overwhelmed
by the benefits it brings. Those benefits include lower-priced
imports for U.S. and other world consumers and businesses; they
include expanding export opportunities to China; they include
advantages of Chinese capital flowing to the U.S. and other industrial
nations. Indeed, most of what we import from China fits in the
category of consumer goods that improve the lives of millions
of Americans every day at home and in the office. Of the $243
billion worth of goods we imported from China last year, more
than 80 percent were computers and computer accessories, cell
phones and other telecommunications equipment, furniture, appliances
and other household good, clothing and shoes, toys and sporting
good, TVs, radios and other consumer electronics. The remaining
20 percent of imports from China last year were industrial supplies,
industrial machinery, transportation equipment, food, and energy.
other words, globalization is here to stay and China has dramatized
the answer to the second question is no less significant. China's
unprecedented growth is not without risk. Clearly, government
officials here are increasingly concerned about the potential
of overheating in the economy. It recognizes the need to restrain
its record trade surplus, fast-rising foreign exchange reserves,
and ballooning current account surplus. It is aware that it should
slow export growth and encourage imports, lower its savings rate,
and boost domestic demand. Indeed, the government has already
taken steps to help alleviate some of these concerns. The main
policy measures are intended to boost domestic demand by reducing
tax, increasing household income, speeding up infrastructure
building in rural areas, encouraging financial institutions to
extend consumer credit targeted at individuals. It has also moved
minimum bank reserve requirements and allowed the yuan to strengthen
twice as fast in the second half of 2006 as it did in the 12 months
since revaluation in July of 2005.
Those are important measures. But there is more to be done. One
paramount step toward this goal is develop strong, liquid and efficient
capital markets. To achieve this result, most world economies have
turned to financial derivatives.
everyone here knows, financial derivatives allow the transfer
of inherent business risks, such as in foreign exchange, interest
rates or equities to those most able and willing to assume and
manage the risk involved. Thus, they act as a gigantic insurance
mechanism that allows financial market risks to be adjusted quickly,
more precisely, and at lower cost than is possible with any other
financial procedure. In doing so they allow capital to be used
in a more productive fashion to the benefit of the overall economy,
a process that will improve national productivity, growth and
standards of living. Allow me to quote Alan Greenspan, the past
Chairman of the U.S. Federal Reserve Board:
allowing for a more efficient management of risk derivatives
have resulted in a more efficient allocation of capital. An efficient
allocation of our resources, including capital, allows for more
rapid global economic growth. It is through economic growth that
each generation has the ability to live better than past generations.
Thus, an expanded efficient use of derivatives is an important
component for future economic growth."
most financial people are aware, the era of financial derivatives
was inaugurated in a series of revolutionary financial innovations
originating at the futures exchanges in Chicago in the 1970s
and early 1980s. It accelerated the movement toward financial
engineering, the development of OTC products, and spawned financial
futures exchanges in every corner of the globe—from Argentina
to Australia, from Italy to India, from London to Kuala Lumpur.
Virtually every currently successful exchange-traded derivative
is a simple translation of one of the Chicago
initiated products to a geographically different underlying market.
ultimately catapulted Chicago Mercantile Exchange as the foremost
futures market in the world. Alan Greenspan, the former Chairman
of the US Federal Reserve stated that "The financial derivatives
markets, which the IMM has played a critical role in developing,
have significantly lowered the costs and expanded the opportunities
for hedging risks that previously were not readily deflected.
As a consequence, the financial system is more flexible and efficient
than it was 30 years ago, and the economy itself may be more
resilient to the real and financial shocks." Nobel economist,
Merton Miller named financial futures as "the most significant
financial innovation of the last twenty years."
week's historic agreement merging the CME and the CBOT is another
major step in the evolution of our markets. The combined company
to be known as, CME Group, will bring together two proven industry-leading
innovators to create a single company, strengthening its ability
to grow in an increasingly competitive environment. The combined
company will provide one of the most liquid marketplaces, with
average daily trading volume approaching 9 million contracts
per day, representing approximately $4. trillion in notional
value. The combined company will provide customers worldwide
efficient, global access to a wide array of benchmark exchange-traded
derivatives base on U.S. interest rate yield curve, equity indexes,
foreign exchange, agricultural and industrial commodities, energy
and alternative investment products such as weather and real-estate.
there is little controversy about the subject. The vast majority
of the global economic establishment agree that financial derivatives
markets have significantly lowered the cost of doing business
across the entire circumference of the economic landscape. As
a consequence, capital markets are strengthened, the allocation
of capital is more efficient, and national productively is improved.
Ultimately, the standard of living is enhanced and social order
is greatly benefited. Indeed, the government of China is cognizant
of this reality as well. During the last few years it has taken
significant steps in the direction of financial derivatives.
It has also encouraged the creation of new domestic financial
instruments, such as a swap market to give local companies more
opportunities for hedging risk. Indeed, the CSRC is presently
taking the giant step of authorizing the creation of China's
first financial derivatives exchange. Proudly, we believe that
the Chicago Mercantile Exchange has provided assistance in many
of these endeavors.
I said before, all of the above are links in a continuous chain
of advancing the maturing of Chinese capital markets. One of
the major and historic moves in this direction again occurred
with the CME. Last year as a consequence of extensive discussions
with the Chinese government, the CME forged a unique and unprecedented
agreement with the Chinese Foreign Exchange Trading System (CFETS).
This multi-year strategic partnership will provide Chinese financial
institutions and investors access to electronic trading of CME
foreign exchange and interest products. As part of the agreement,
CFETS will become a CME super-clearing member, providing services
for investors based in mainland China who will be able to trade
CME interest and FX products. In addition, CME and CFETS will
jointly provide consulting, training, and technical services
to CFETS members and staff.
a further sign that the government of China has changed its attitude
toward its exchange rate policy is the fact that the Chicago
Mercantile Exchange has introduced futures and options contracts
on China's renminbi against the U.S. dollar, euro and Japanese
yen. Before it did so, the CME had extensive discussions with
Chinese government officials about these plans and ultimately
received Beijing's acceptance. Clearly the introduction of the
futures FX contracts will create more opportunities for price
discovery in the renminbi and further the goal of liquefying
Chinese capital markets.
course these are sophisticated instruments which require expertise
and experience. In this respect, the Chicago Mercantile Exchange
stands ready to continue its advice and assistance to the government
of China as well as its financial community in helping develop
financial derivatives markets in China. Congratulations at this
juncture in your history, the dawn of derivatives markets in
China. Thank you.