Remarks by Leo Melamed
The Chinese Finance Association
19th Annual Conference, New York University
November 3, 2013
As everyone knows, a long time ago, philosopher Lao-tzu said, “A journey of a thousand miles begins with a single step.” My personal single step toward China began in July of 1985. It was then when President Li XianNian visited me in Chicago at the Chicago Mercantile Exchange. President Li was the very first Chinese President in history to ever set foot on American soil. It was an enormous honor for me and the CME, and it initiated my love affair with the people of China.
I believe, President Li had a special reason for visiting the CME first, not Washington DC or New York. By 1985, it was already well known that the CME was the capital of financial innovation. We represented the essence of free markets. President Li wanted to send a strong message to the world that the people of China were ready to turn the economic corner. By coming to us, “the bastion of change,” rather than anywhere else, President Li told the world that China too was open to economic change. As everyone knows, Deng Xiaping followed Li Xiannian’s lead and became the primary architect and driving force behind China’s radical transformation in the late twentieth century.
For the past three decades, China's story has been one of rapid economic steps, driven by export-focused manufacturing. During this time-frame, China became an industrial giant, moving up the ladder from production of clothing and footwear to the high level production of computers, pharmaceuticals, and machinery---even to the ambitious path of conquering the mysteries of space.
However, the most important question now is the path China will take moving forward. Having reached this plateau of success, what must it do to maintain its momentum and achieve the potential it now represents? Although China has become the world’s second largest economy after the U.S., it is still a long way from assuming its place among the developed nations of the world.
China’s growth during the past three decades---during its period of infrastructure development and rural-to-urban migration---was fostered in part by protection of its domestic economy and currency stabilization policies. It was the prudent thing to do. However, as emerging economies achieve success, develop large-scale corporations, and build a middle class, their economic agenda should materially evolve. In my opinion, China’s corporations and its consumers have reached stages of economic size, growth, and wealth, where global risk management tools are increasingly essential as they seek to reach for higher growth on a world scale. In other words, it is imperative that China continue to create greater liquidity in its underlying cash markets.
Increasing liquidity is about improving the functioning of markets so that participants can easily buy and sell debt or securities, or borrow and lend, without causing large price movements. Liquidity in futures markets will work to improve liquidity in the cash market. Thus, recent Chinese moves to create a futures crude oil, and a bond is an important step in this direction. However, more tools for risk management are needed to integrate with the cash markets in order to allow every segment of the marketplace to function together and more efficiently. As the World Trade Organization, underscored at the outset of the 21st Century, financial services are the backbone of modern economies. It is difficult to point to any economic activity that does not depend in a significant way upon services provided by the financial sector.
The CME, as you are aware, has been the prominent leader in China in this respect. We have traveled to China in continuous fashion over the years, meeting with leaders and responding to their queries with respect to the development of Chinese futures. We have provided advice and participated and created futures seminars. We executed formal MOUs with all four futures exchanges in China and provided continuous assistance. We have hosted continuous delegations both in China and the U.S. with workshops and seminars. We organized educational programs for the CSRC, futures exchanges, top futures and securities firms and FCMs. A few years back, in 2006, we organized the first financial derivatives forum with the Shanghai Futures Exchange and the Shanghai Stock Exchange toward the goal of creating a financial futures Exchange. Today, the financial futures exchange (CFFEX), trading the CSI 300 index, is a huge success. We are encouraging cross-border capabilities and have hosted a multitude of Chinese FCM firms. We are promoting membership status for the major Chinese banks and securities firms. Recently the Bank of China became the first Chinese clearing and settlement bank at the CME. I could go on and on, but without a doubt the CME has been the most active exchange in the world in assisting the development of Chinese capital and futures markets.
Chinese futures exchanges have done exceedingly well. They are liquid and well-managed. However, they are nearly completely domestic. They are isolated and insulated from world participation or international competition. Until they become subject to cross-border interaction, their full value to the Chinese economy is limited. Nor can their true competitive strength be measured. Allowing foreign firms and foreign hedgers and traders to participate and compete will strengthen the exchanges, result in more open and efficient capital markets, and help transition China to a nation of investors and not just savers. I am very certain that Chinese leadership and the CSRC are fully aware of this truth.
To be clear: My main message today is that China must open its markets to global competition. The pendulum has now swung to the other side. Keeping protections in place too long will lead to a lack of innovation, low productivity, and poor service and can hurt the development of the country. China’s rapid modernization has taken the country’s economy to a new level where a lack of global integration now hinders the international expansion of its world-class companies and prevents its middle class from the benefits of international portfolio diversification. Global integration that might have caused domestic challenges in the past now offers the path to more rapid economic growth.
In its report, the WTO pointed out that internationally-open financial markets enhance economic welfare and growth through more efficient intermediation between savers and investors. Precisely the objectives of the current Five Year Plan. Former Secretary of Treasury, Henry Paulson, recently wrote in the Wall Street Journal, “If China is to achieve its new economic model it must introduce competition into its economy.” I emphatically support this view.
In addition, there are geo-political advantages for China shifting gears toward more rapid global integration of its financial markets. A strong and open currency market is another critical characteristic of major industrial powers. Moving toward a normalized currency would make a decisive and significant statement that China is ready to take on the mantle of world economic leadership. I am fully aware of the important strides already made in recent years. In June of 2010, the Chinese Central Bank, the PBOC, took an important step towards internationalizing the RMB by introducing offshore RMB deliverable in Hong Kong (CNH). This move enabled corporations anywhere in the world to settle transactions in RMB. It led the CME to develop a USD offshore RMB futures contract deliverable in Hong Kong. The current thinking is to achieve basic convertibility of the capital account by 2015 and full convertibility by 2020. I would urge that this pace be quickened. Full convertibility would vastly improve the international standing of the RMB, and promote the internationalization of the Chinese currency.
I cannot conclude these remarks about the Chinese progress without recognizing that last month China’s leadership announced a basic plan for a newly established free-trade zone in Shanghai. It would give foreign companies greater freedom in the country’s regulated financial markets. We applaud this move although all the rules are still unknown. The move gives clear evidence that the administration of Xi Jinping is prepared to move forward with globalization of Chinese markets. The move will also assist Shanghai in its quest to become a leading center of finance in Asia.
In conclusion, I must also note that the third plenum of the 18th CPC Central Committee will be meeting between November 9 and 12th. Coincidentally, I will be in China at the same time meeting with the IAC, the International Advisory Council of the CSRC. The third plenum is seen as a potentially crucial meeting for the President to lay out his policy objective for what is expected under his charge in the coming decade. In a recent statement Mr. Xi Jinping said, “We will study the issue of comprehensive reform and make an overall plan.” I feel optimistic that it will provide a clear path toward globalization of Chinese markets. My love affair continues.
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