China and East Asia
Prospects of Financial Cooperation
September 23, 2003
Beijing, China

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We stand at the dawn of the Twenty First Century. Admittedly, the geopolitical landscape is laden with controversy and danger. Similarly, there exists the specter of economic difficulties within many regions of the world. Nevertheless, there is abundant reason to be optimistic. To state the obvious: The Twenty First Century represents unlimited opportunities for humankind. That sentiment is especially true for China and East Asia.

Allow me to elaborate—but to do so, allow me first to make some comparisons and review where the world stood exactly 100 years ago, at the dawn of the Twentieth Century. What can we learn from the past century? What insights can we glean? How can we apply the lessons learned?

It is perhaps instructive to remember that at the outset of the last century, Sigmund Freud had just published his "Interpretation of Dreams," and Albert Einstein had just unveiled his famous three papers on relativity. Britannia was still the empire on which the sun never sets; the railroads were in their Golden Age, automobiles were considered a passing fashion, and in America the phonograph was the most popular form of home entertainment.

Unfortunately, right from the beginning, the Twentieth Century offered extensive testimony of its message of hate and violence. In France, the Dreyfus Affair had reared the ugly head of bigotry; in the U.S., the Supreme Court delayed civil rights by embracing the separate but equal doctrine; the Spanish-American War had begun; American President William McKinley was assassinated; the Russo-Japanese War broke out; and there was a bloody rebellion in Russia at St. Petersburg.

In other words, not too much different than at the dawn of the present century.

One therefore cannot fault a historian if he characterized the last century as one plagued by conflict and social upheaval. Indeed, the Twentieth Century included a new low in the history of mankind—two world wars and the Holocaust. Still, as my father optimistically said to me: "Don’t forget, the world went from the horse and buggy to the Moon."

In other words, if there is a single lesson to be gained from the momentous upheavals of the Twentieth Century, it will not be found in the political or economic arena, but rather in the sciences. In spite of the horrors that unfolded, science and technology dominated the destiny of that century. I have no reason to believe that the Twenty First Century will be different. In this respect, it is instructive to underscore that the technological lynch-pin of what occurred during the last century was devised precisely on December 23, 1947—right in the middle of Twentieth Century. For on that day, three Bell Laboratory scientists in the US who ten years later received the Nobel Prize in physics—William Shockley, John Bardeen, and Walter Brattain (who coincidentally was born in Amoy, China)—had invented the first transistor. It was the birth of a technology that would serve to dominate the balance of the Twentieth Century and clearly much of the Twenty-first. The Digital Age was born.

By this measurement, our present century is still decades away from its defining invention.

Lest we forget, transistors and their offspring, the microchip, transformed everything: The computer, the space program, the television, the calculator, the automobile, the telephone, and, most important, telecommunications. It enabled the world to migrate from the gold standard to the "information standard." The new era fostered instant mass informational flows in total disregard of internal prohibitions or national boundaries. Simply stated, the technology of the Twentieth Century moved mankind from separate and insulated geographical regions toward an interdependent world economy. Globalization was upon us.

As a consequence, today, at the dawn of the Twenty First Century, 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 mankind___mostly 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 made 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. 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. 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 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.

Allow me to quote from the congratulatory message by Alan Greenspan, Chairman of the Federal Reserve Board, to the Chicago Mercantile Exchange on the Thirtieth Anniversary of its launch of financial futures at the International Monetary Market division, the IMM:

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.

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 controversy 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 derivatives market 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 the development of a Renminbi futures market.

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 three important futures markets: The Shanghai Futures Exchange (SHFE), the Zhengzhou Commodity Exchange (CZCE), and the Dalian Commodity Exchange (DCE). 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 recently execute a historic Memorandum of Understanding with the Shanghai Futures Exchange. Our agreement will provide expertise and education to the SHFE toward the goal of making it a leader in China and East Asia and ultimately provide a mechanism to distribute its products internationally.

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.

Of this I am certain: The Twenty First Century, no different than its predecessor will be dominated by scientific and technological change. While those changes cannot be foreseen with precision, they will determine its destiny. However, the following truth will not change: We will continue to live in a highly complex and hazardous economic environment where information will continue to travel at Internet speed. We will continue to live in a world in which competition will remain intense and global, where interest rates, exchange rates, and other asset prices will remain volatile, and where dangers as well as opportunities will continue to rapidly appear and disappear on a constantly changing financial horizon. We will continue to live in a world where the possibility of any economic dislocation, the prospect for any change in value or price, the expectation of any alteration in national economic policies, whether it be the result of international turmoil or the consequence of domestic business disruptions, whether it be in finance or agriculture will demand the means by which to limit the attendant risks or an opportunity to capture the perceived or real profit potential.

Those realities represent the opportunities and challenges in the Twenty First Century for the markets in China and East Asia. I am confident you will succeed.

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