VZCZCXRO8811
OO RUEHCN RUEHGH RUEHVC
DE RUEHBJ #3122/01 3200953
ZNY CCCCC ZZH
O 160953Z NOV 09
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6850
INFO RUEHOO/CHINA POSTS COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RHEHNSC/NSC WASHDC PRIORITY

C O N F I D E N T I A L SECTION 01 OF 03 BEIJING 003122 

SIPDIS 

STATE FOR E, EAP, EAP/CM 
TREASURY FOR OASIA/DOHNER, WINSHIP AND LOEVINGER 
NSC FOR LOI 

EO 12958 DECL: 11/16/2034 
TAGS OVIP, ECON, ETRD, EFIN, PREL, PGOV, CH 
SUBJECT: U/S HORMATS’ MEETINGS WITH BEIJING ECONOMISTS: 
REBALANCING, TRADE FRICTIONS, AND EXCHANGE RATES
REF: A. BEIJING 3090  B. BEIJING 3102

Classified By: Economic Minister Counselor William Weinstein; Reasons 1 .4 (b, d)

¶1. (C) Summary. Vice Minister Liu He of the Central Leading Group on Financial and Economic Affairs (CLGFEA) told Under Secretary for Economic, Energy, and Agricultural Affairs Hormats on November 9 that the small number of bilateral trade conflicts generates disproportionate political and social impact in both countries. The Chinese Government understands the need to resolve these conflicts and to build mutual trust. On rebalancing, Liu agreed that U.S. savings and Chinese consumption both need to rise, with both sides having “a long way to go.” Liu is involved in preparation of China’s next Five-Year Plan (covering 2011-15), two core elements of which will be boosting domestic demand, especially consumption, and promoting urbanization. Other policies, including those related to education, social safety net, low-income housing, and infrastructure would flow from these rebalancing themes.

¶2. (C) Summary, continued. Both Liu and Chinese Academy of Social Sciences (CASS), Institute of World Economics and Politics Director Zhang Yuyan voiced concerns about possible future inflation in the United States, which could erode the value of China’s USD-denominated investments, and about USG and Federal Reserve exit strategies from stimulus programs. On exchange rates, Zhang acknowledged the need for China to alter its system and said several options are under consideration, including return to the July 2005-August 2008 peg system, using either the SDR or a trade-weighted basket of currencies rather than the USD as the peg. He said two arguments in favor of RMB appreciation were that an undervalued currency caused China effectively to subsidize foreign consumers, and that pressure on China from the rest of the world was rising. On the other hand, China feared currency appreciation would cause more bankruptcies in China’s exporting coastal regions. End Summary.

¶3. (C) In his separate meetings with Liu and Zhang, U/S Hormats emphasized that his goal was not to use this visit to negotiate, but to get a sense of what was on the minds of Chinese policy makers as they considered future plans and strategies. The conversations were remarkably candid. U/S Hormats’ other meetings are reported in reftels.

Trade Frictions: Small Numbers, Large Impact
-------------------------------------------- 

¶4. (C) Noting the need for a strategic approach to bilateral relations, U/S Hormats told Vice Minister Liu the most complicated current issues are trade and rebalancing. On trade, the areas of friction actually are very small as a percentage of overall trade, but the disputes sometimes get blown out of proportion. Liu described the trade conflicts as “terrible,” with the small number of disputes having huge political and social impact in both countries. He believed U.S. labor unions and upcoming mid-term (2010) U.S. elections both increase pressure for trade protectionism in the U.S. In China, Liu said local governments want to protect their own tax bases and industries. The two sides need to work together to resolve these problems for the good of both countries and the rest of the world.

¶5. (C) U/S Hormats observed that the upcoming visit of President Obama to China presents an opportunity to conclude agreements on clean energy and/or climate change. These are very high priorities for the United States and would benefit our overall relationship. He also stressed the need to have further talks led by USTR Ambassador Kirk and Secretary of Commerce Locke. The U.S. aims to resolve trade issues if possible through discussion and negotiation, Hormats emphasized. Liu said the Chinese Government understands the need to resolve the trade disputes. He also agreed on the need to maintain dialogue on major strategic issues for the medium and long terms, observing that “we need each other” but at the same time distrust each other in many ways.

Rebalancing
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¶6. (C) Vice Minister Liu concurred with U/S Hormats that U.S. savings and Chinese consumption need to rise, and said both sides have “a long way to go.” For the first nine months of 2009, China’s GDP growth reached 7.7 percent, including
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increases of seven percent in domestic investment and four percent in consumption, with negative 3.6 percent growth in net exports; Liu said this demonstrates China’s efforts to boost consumption in the short term.

¶7. (C) Liu said he had met that morning with senior leaders to discuss preparations for the 12th Five-Year Plan (covering 2011-15). Two core elements of the plan will be boosting domestic demand, especially consumption, and promoting urbanization. Other policies, including those related to education, social safety net, low-income housing, and infrastructure would flow from these rebalancing themes. Liu believes the U.S. economy will require 2-3 years to recover from the global crisis, during which time China’s external markets will remain shrunken. He claimed China’s leaders had formulated a new development strategy in 2007, before onset of the global crisis, to promote rebalancing away from exports and industrial investment in favor of technological progress and domestic consumption. (Comment: Liu did not expand upon the urbanization topic, but the next plan presumably will address many of the social needs and consequences generated by China’s relatively rapid and continuing urbanization trend. Expansion of programs to address needs for housing, health care, education, and other social services for recent urban migrants and their families would correlate closely with overall rebalancing initiatives.  End Comment.)

U.S. Economy: Watching and Worrying
----------------------------------- 

¶8. (C) Vice Minister Liu said he was “a little worried” about the path of the U.S. economy, fearing it might be reverting to the past model: the Fed was “printing lots of money” and the stock market, which “has no memory,” was rising too fast.  After hearing assurances from U/S Hormats about the U.S. desire to assure that a strong recovery took hold and ongoing Federal Reserve and USG vigilance to avoid repetition of the financial excesses of the past, Liu appeared reassured about the soundness of the U.S. approach but said both countries needed to pay attention to any future “bubbles.” A return by China to its old ways and traditional growth path would not be good for China or the world, he said. CASS Director Zhang also was concerned about possible future inflation in the United States that could erode the value of China’s USD-denominated investments. He inquired about USG and Fed exit strategies from stimulus programs and progress on health care reform and climate change legislation. (Comment: The concerns of Liu and Zhang about the U.S. economy parallel those expressed by various other economic policy officials in recent meetings. End Comment.)

Exchange Rates
-------------- 

¶9. (C) CASS Director Zhang said the renminbi (RMB) exchange rate is a current discussion and research topic at CASS and within the government, and there might be “some surprise” in the coming months. As China moved toward more domestic demand-based economic growth, it would need to alter its exchange rate system. One possibility would be return to a system similar to the July 2005-August 2008 peg, using either the SDR or a trade-weighted basket of currencies rather than just the USD as the peg. Zhang observed that his predecessor as CASS Director, Professor Yu Yongding, had been a strong proponent of a sharp appreciation (ten or more percent) of the RMB against the USD. Zhang said two arguments in favor of RMB appreciation were that an undervalued currency caused China effectively to subsidize foreign consumers, and that pressure on China from the rest of the world was rising. On the other hand, the Chinese Government feared currency appreciation would cause more bankruptcies in the exporting coastal regions.

¶10. (C) Zhang said he recently visited Japan for discussion of exchange rates, among other issues. In his opinion, China now is “at a crossroads” and faces two main options: first, moving with other countries in the region to some form of common Asian currency; or second (and more likely), keeping the RMB independent with a view toward playing a greater international role in the future. CASS senior fellow Jie Sun added that two possible currency baskets were under consideration: a more traditional basket of major currencies including the USD, or a regional currency basket, although the latter option would be difficult due to lack of any regional surveillance system. Zhang added that a paper published in March 2009 by People’s Bank of China Governor
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Zhou Xiaochuan advocating development of another world currency, possibly based on the SDR, represented Zhou’s “personal view” but also reflected dissatisfaction with the existing system among some Chinese officials and economists.

¶11. (SBU) U/S Hormats has cleared this cable. 
HUNTSMAN