This interview was conducted by Yanping Gao and was first published on Guancha Net on June 19, 2014.
The difficulties of internal and external foreign exchange reserves are much discussed. Though the importance of foreign exchange reserves is self-evident, there are some who are concerned that China’s excessive foreign exchange reserves are putting pressure on domestic inflation and external RMB appreciation, or may be subject to control in future because of the risk of devaluation.
At the beginning of June, Fanchen Meng was invited by the Tongji University School of Economics and Management, his alma mater, to give a lecture on the “Humanistic Attainment of European Elites.” He took this opportunity to analyze how China uses its 4 trillion U.S. dollar’s worth of foreign exchange reserves. After the meeting, Guancha Net interviewed Fanchen Meng and Dr. Yibin Li, from the Tongji University School of Economics and Management, in response to the core opinions that caused much discussion.
Fanchen Meng is from China. In 1991, he obtained an economics doctorate in Germany. He has previously served as the global vice president and partner of Kearney, senior vice president of Siemens China, vice president of the French Lafarge Group and global partner at Heidrick & Struggle.
Foreign exchange reserves are financial nuclear weapons
Guancha Net: There has been a lot of domestic discussion about foreign exchange reserves. Both authoritative institutions and prestigious economists have had much to say. For example, that foreign exchange reserves have caused enormous pressure on domestic inflation and external RMB appreciation. Also, they are easily controlled by others. Once the dollar depreciates, the loss will be immeasurable. Therefore, some economists, such as Zhang Weiying, came up with the idea that foreign exchange reserves should be distributed to the people, thereby ‘storing the wealth among the people.’ Do you have different views on this?
Yibin Li: Domestic economists mainly base their views around foreign exchange reserves on the following logic: First, that the sources of China’s foreign exchange reserves are foreign trade surplus and second, the net inflow of foreign direct investment, i.e., a double surplus of international payments.
Before 2008, China had been implementing a foreign exchange system of compulsory export settlements and sales. Export companies retained less foreign currency, and more foreign currency funds were represented in the form of central bank foreign exchange reserves.
When the central bank buys foreign currencies, it must issue an equivalent amount in the base currency, which, through the enlargement of the money multiplier, will lead to the multiplication of the money supply in circulation and increase inflation. At the same time, in order to maintain and increase the value of foreign exchange reserves, the central bank can only invest the reserves in safe and realizable U.S. Treasury bonds and real estate mortgage bonds.
However, due to the large amount of currency issued by the United States after the financial crisis, which led to the devaluation of the U.S. dollar, and the low-interest rate on U.S. debt, many government officials and economists believe that the large amount of foreign exchange reserves has become a burden for China. This has trapped them in a dilemma: not stockpiling U.S. dollar foreign exchange reserves risks a run on the banks, causing a financial crisis, while stockpiling U.S. dollars results in a low rate of return is a waste of funds. As a result, some economists have suggested that they should reduce China’s foreign exchange reserves and change “stockpiling wealth in the country” to “storing the wealth among the people.”
As for the statement that foreign exchange reserves should be directly distributed to the people – if the original intention of this view is to advocate that the central bank and the foreign exchange administrations reduce the restrictions on foreign exchange holdings and foreign investment by enterprises and residents, it is indeed possible to “store wealth among the people.” If it is to distribute it to the people directly, I think the statement is ridiculous, because as the central bank has already paid the fees when buying this foreign currency, it is impossible to distribute it to the people free of charge.
Fanchen Meng: Professor Zhang is right to be worried about the officials who control these foreign exchanges. It goes without saying that the preservation of foreign exchange reserves at the operational level requires relevant decision-makers to have global experience and capabilities while being familiar with the relevant systems, processes and best practices in other benchmark, developed countries. However, there is an underlying, strategic issue when it comes to foreign exchange reserves that must be addressed.
Firstly, let us take a global view of the significance of a 4 trillion foreign exchange reserve. For those Western European and North American political and business leaders that still have a Cold War mindset, China’s 4 trillion U.S. dollar foreign exchange reserves are like the sword of Damocles that its political and economic systems have yet to control.
A leaked conversation between the former US Secretary of State, Hillary Clinton, and the Australian Prime Minister, expressed precisely this anxiety. The United States are helpless with China as their largest foreign creditor. It also, very typically, showed that some leaders in the West are not only worried but also hostile towards China’s rise: Where money is power, a group of poor people organized by the Chinese Communist Party is seen as a threat that must be broken.
There are, of course, also those in the Western world who applaud China’s rise and sincerely believe that the world benefits from China’s poverty alleviation and vested interests. The 4 trillion U.S. dollars are undoubtedly the Chinese economy’s most useful resource for integrated development, a better future, and mutually beneficial for developed countries.
For China, this huge foreign exchange reserve is a direct result of hard currency wealth accumulated by ordinary Chinese consumers during the 30 years from 1978 to 2008, who have suffered from the inflation caused by the additional issue of an RMB equivalent. The hard currency wealth is the most direct achievement of hard work in China. Theoretically or academically speaking, the accumulation of foreign exchange reserves has come at the cost of past inflation. But the inflationary impact of the foreign exchange reserve itself has been borne by ordinary people for the past 30 years. The foreign exchange reserve actually represents what the Chinese public already owns. It is the right to purchase Western physical assets that can be cashed in at any time. Any clearance of this in the future, i.e., the purchase of overseas products or assets, will alleviate existing inflation in China.
At present, this U.S. $ 4 trillion foreign exchange reserve is favorable, and there is no danger of further inflation. How should foreign exchange reserves be used? In fact, like in Mark Twain’s “Million Pound Note,” not using it is best. These four trillion dollars are actually a kind of a financial credit for China as a whole, just like when the Chinese people in the Mao era lived frugally and developed the atomic and hydrogen bombs as a strategic nuclear deterrent to defend our country without war. The 4 trillion U.S. dollar foreign exchange reserve is a strategic deterrence and guarantee for China’s existing economic development model, especially the financial control model. No gambler or institution in the world can dare gamble with the U.S. $ 4 trillion, thereby potentially destroying our stock market and suppressing the value of our currency and assets.
If the U.S. $ 4 trillion is used as bank stock capital, in accordance with the latest not yet fully implemented capital requirements of the Basel III bank, China can issue the equivalent RMB of U.S. $ 44 trillion overseas. Doing this would be a sensible move for China, easing current inflation and releasing a huge amount of domestic RMB to developed nations. Again, using leverage and keeping a conservative ratio of 1:8 or 1:10, US $44 trillion signifies that an efficiency of at least US $400 trillion can be produced.
Take Fosun’s recent acquisition of Portugal’s largest insurance company as an example. It invested US$ 1.36 billion to purchase 80% of its shares, regardless of its own capital ratio. Fosun thus has control over the insurance company’s total assets of 11 to 12 billion euros. Leveraging the pockets of public pension funds, individual shareholders of financial enterprises and taxpayers, a small number of financial leaders in Europe and the United States are deciding about the fate of the financial world.
How do we conceptualize 400 trillion dollars? In 2008, the global financial crisis, which threw the Western world into chaos, was caused by about 2 trillion US dollars – transferred from the pockets of public pension funds, individual shareholders of financial enterprises and taxpayers, into the hands of a small number of financial elites in Europe and the United States. Any talk about breaking up the 4 trillion dollars is precisely Western leaders want. If it is not the fear of maintaining value at the operational level, or lack of common sense among Western leaders, there must be another ulterior motive.
If you really want to give back to the people and reduce the pressure of domestic inflation, this requires using reserves as principal and credit: accelerating the pace of exporting RMB to the world, and transferring domestic accumulated inflation abroad. As far as possible, we must promote that international transactions be settled in RMB. This is the best way to preserve the strategic value of the 4 trillion U.S. dollars in foreign exchange reserves.
Yibin Li: Just like the United States, moving the U.S. dollar abroad. Only one-third of the U.S. dollar circulates domestically, two-thirds of the U.S. dollar is abroad. Therefore, if the United States engages in Q.E., domestic inflationary pressure will not be very high. To the contrary, many things are cheaper than the rest of the world, including in the manufacturing countries.
A new Opium War?
Guancha Net: This ties in with what Dr. Meng said about the new Opium War. The Opium War of more than 100 years ago was fought with opium. The new Opium War of the present age uses the currencies of developed countries such as the U.S. dollar and the Japanese yen as weapons.
Fanchen Meng: Yes. Recently, the European Central Bank announced for the first time that it would implement a negative interest rate on Eurozone bank deposits, charging a negative interest rate of 0.1 %. With the U.S. and Japan’s overnight, short-term loan interest rates being cut to zero, the main owners of monetary savings in developed countries will all face a real depreciation of related wealth due to inflation. At the national level, countries with large amounts of hard currency wealth, especially resource-exporting countries like the Middle East and Russia, and China, which has accumulated a large amount of monetary wealth from developed countries, will face a significant reduction in this monetary wealth. This is the “new opium war” that I mentioned in my presentation, that is, developed countries have issued currency to suppress interest rates.
Only this time, it is to silently move against countries with large amounts of their monetary wealth. So the best way for China to deal with this new Opium War, to maintain the value of its existing foreign exchange reserve, and at the same time to ease the appreciation of the RMB to the outside world and the depreciation to the inside, is to use the RMB to exchange the hard currency for foreign exchange and to buy the real assets of investment in developed countries.
Therefore, the best way for China to respond to this new Opium War and to maintain the value of its existing foreign exchange reserves, while at the same time easing the RMB’s external appreciation and internal depreciation, is to exchange RMB for hard currency to buy real physical assets in developed countries. Internationally, because it already has a 4 trillion foreign exchange reserve and related credits, others are willing and have reason to trust the RMB. This is a necessary prerequisite for the export of the RMB. If Chinese people go abroad to buy things, like luxury goods or enterprises, and use the RMB to settle accounts, the RMB will flow overseas, greatly easing the pressure on internal devaluation and external appreciation.
China’s mainstream media and some so-called experts have a theory that the precondition of exporting RMB is the deregulation of Chinese capital market. This is actually likely to benefit the West, and is especially preferred by the United States, whose financial industry has an overwhelming advantage and could strengthen their effective control of China’s foreign exchange reserves. Both Germany and Japan are economic powerhouses, but they are both dwarfs in the financial industry. The reason for this is the unmatched competitiveness of the U.S. financial industry after World War II and the appropriately matched status of the U.S. dollar. This ultimately determined that Germany and Japan must rely on America in the financial capital market. The most significant achievement of China’s development over the past 30 years has come from the effective management and control of its own savings, its capital self-reliance, and the low capital cost in infrastructure investment.
The U.S.-manipulated Ukrainian crisis has caused America to experience something unexpected; that is, China and Russia successfully signed a natural gas contract they had been trying to formalize for ten years. When Vice President Biden faced blame for this huge “negative impact,” he weakly argued that it was the result of a 10-year negotiation. There will be downward pressure on the energy market in Asia if Russia and China reach a natural gas agreement. After all, the price of natural gas imported from the United States by Japan is 20 % to 50 % higher than the price of natural gas imported from Russia by Western Europe. In the long run, it will be possible for China and Russia to settle accounts in rubles or RMB, especially if the U.S. continues to suppress the international living space of China and Russia politically and economically, which poses a considerable risk and challenge to the status of the U.S. dollar. As far as the Chinese RMB is concerned, this is an excellent opportunity for the RMB to increase its global scope.
Therefore, when discussing the preservation of foreign exchange reserves, we must first answer the question of how to expand the use of the RMB in the international arena, not just the issue of the opening RMB capital markets. The Chinese government must first fully develop and promote the RMB demand overseas, leading by example by using the RMB overseas.
One thing is sure; the RMB will definitely become a major international trade currency because China is the country with the most skilled labor, the cheapest production capacity, and the largest surplus in the world. We are different from the individual export of Indian labor. A proportion of China’s labor force is exported collectively, many of them because government-backed companies have contracted large projects overseas, and workers have followed. If RMB settlement is given priority, projects like this, as well as overseas purchases of large-scale equipment, will be more beneficial to the promotion of RMB internationalization.
Guancha Net: This is not a unilateral wish; the key is only for the other party to accept it.
Fanchen Meng: Everything can be negotiated, and this is a process that cannot be accomplished overnight. The Chinese government has signed RMB exchange agreements with many central banks in Western countries, which has created good prerequisites for meeting overseas RMB demand. In the next step, all international trade or investment projects in which the government and state-owned enterprises are involved must prioritize the use of RMB as much as possible to increase the demand for overseas RMB. Our biggest advantage is that we have $ 4 trillion in credit. In addition, they can use RMB to buy what they want, because “Made in China” is already available everywhere. Europe’s major central banks are already secretly using the RMB as a reserve currency. They want to maintain their value and make money.
Guancha Net: This was also reported in the media last year, but why secretly? What is the cause?
Yibin Li: No one knows the precise currency structure of every country’s foreign exchange reserves. It is a secret, as is China’s. Furthermore, due to the uncertainty of the U.S. dollar and Euro, the world is transitioning to a multi-currency reserve system. The RMB is expected to gradually become an essential part of the multi-currency reserve system.
Fanchen Meng: Before the U.S. exerts itself to suppress China and demanded the free exchange of RMB and the opening of its capital accounts, and before China meets these conditions set by the U.S., accepting RMB as a transaction or even as a reserve currency is a “political mistake only made at gunpoint” in the Western world. What’s more, helping the RMB’s internationalization is a big taboo that violates the U.S. leader’s maintenance of the U.S. dollar’s status. This insight has been personally shared with me by insiders.
There are two major advantages to RMB reserves. First, the interest rate of the RMB is the highest in the world. Second, after the beginning of the year, the RMB not only had unidirectional appreciation but also started to float bilaterally. However, in the long run, it is generally believed that the RMB can appreciate by about 3% every year due to economic growth; this, in addition to the difference in interest rate levels, will result in a 4% to 6% return. After I joined the French company Lafarge, I suggested that Lafarge issue RMB bonds in Hong Kong. They cleverly did not make it public on the market. Instead, they gave them to the company’s major shareholders. Later, the bond’s real yield would be as high as 15% for the Euro investors.
In such a big environment, investors are willing to ask for RMB to go abroad, but the problem is that we must do it in an organized and coordinated manner. However, many domestic economists are actually trying to deceive the Chinese government, demeaning themselves by demanding that the 4 trillion dollars should simply be divided and forgotten. Its absurdity is equivalent to saying that China should not continue to hold nuclear weapons, because the Chinese nation loves peace, and such weapons are the greatest threat to peace! If the RMB becomes the currency for trade settlements and investment, in most major western countries before the opening of China’s capital and exchange rate controls, China will win the new Opium War. The preservation of China’s foreign exchange reserves will cease to be a problem.
Going out in an organized and coordinated way
Guancha Net: According to your thinking, first of all, you should have a strategic vision and go abroad to buy companies. The second is the specific implementation aspect. We need to organize, discipline, and coordinate outbound investment. At present, many companies are working alone overseas, especially in some countries in Asia, Africa, and Latin America. Because of their political turmoil, our political diplomacy has always taken a position of not interfering in other countries’ internal affairs, which indirectly makes our companies suffer a lot of losses.
Fanchen Meng: Yes, for example, in Libya, Chinese enterprise projects have suffered a lot of losses. European thinking would have us put several anti-aircraft missile systems at the project sites of these countries in the face of NATO’s rampant bombing. The Chinese government affirms that this is to protect our own overseas assets – this is an entirely Western logic, the rules of the game dictate that people will not criticize you for infringing on sovereignty, it is normal in the eyes of the Western leaders.
Guancha Net: Chinese companies are doing some big business overseas, and overseas media will often mention the “China threat theory.” Fishing in our own waters can become a diplomatic event. If there is military action, have you thought about the consequences?
Fanchen Meng: China’s protection of its deep-sea drilling platforms in the South China Sea conflicts with Vietnam. Do you know how Western leaders responded? Their thoughts were simple: “Chinese warships can get in, and your ability to defend it is up to you.” This is the logic of the Western world; the rules of the game. In the past, China could not do what it wanted to do and could only be Ah Q (fooled). Now, if you fight for your own interests in a disputed territory, if you succeed, others will obey you. This is in accordance with the Western rules in play. The Financial Times once published an article condemning China’s actions in the South China Sea, but the comments of netizens below the article overwhelmingly supported China. When Putin seized Crimea, the results of a German opinion showed that the majority of people agreed with and understood Putin.
What prevails in the Western world is the power-driven logic of interest. Why is the German Chancellor being monitored and its energy supply being disrupted by the U.S. through Ukraine? U.S. nuclear weapons are being placed in Germany, and there are still a large number of troops in Germany. There is no right or wrong in interest disputes between states and related diplomatic events. It is the same as attacking the Falkland Islands. Argentina fought the United Kingdom, and the islands belong to them, but they were no match for the U.K. and thus exposed themselves to ridicule.
Guancha Net: So what you mean to say is that we should learn from the United States when investing overseas. Americans invest overseas. Politicians and business circles are tied together. Politicians always strive for the interests of their businesses. Could you give an example of this?
Fanchen Meng: When I was the general manager of Siemens’ largest overseas operation based in Shanghai, General Electric couldn’t compete with us. The U.S. ambassador to China or related personnel would have to fly to Shanghai to put pressure on relevant decision-makers.
The 2007 Siemens scandal is also a good example: The U.S. Department of Justice investigated whether Siemens had violated U.S. laws, even the news of who Siemens bribed in China originated from the United States. At the same time, General Electric was suffering from the financial crisis and was about to go bankrupt. The U.S. government gave them money to help them cope with the emergency. Having this scandal partially diverted the attention of the global public. Of course, this was also to weaken Siemens, whom G.E. could not compete with at the time.
China will definitely need to go through a process to achieve this. Still, China already has the largest, most competitive team of civil servants in the world and doesn’t yet make good use of them would be shameful for their taxpaying citizens and enterprises.
Guancha Net: You also said that we can’t always hide in countries with “nooks and crannies” and make investments. We still have to go to western developed countries, for example, to buy IMB, or to buy Volvo, and play our cards according to the logic of western developed countries. However, at the political level, the new leaders have proposed to develop the “Maritime Silk Road.” One of the reasons is to avoid various trade frictions with the United States and Europe and open up new battlefields.
Fanchen Meng: In essence trade friction is to keep you out of the country, but if we are “behind the enemy,” that is another situation. We don’t have to buy and take shares in the largest companies, but second- and third-tier companies are possible. You can’t buy G.E., but you can buy or take shares in G.E.’s core suppliers, second- or third-tier companies.
There is no problem in investing in Asia, Africa, and Latin America, but there is a reason why Asia, Africa, and Latin America haven’t developed. One of the core reasons is that their vested interests are tied to the West’s monopoly interests. We shouldn’t delude ourselves into thinking that we can solve the problems there. On the contrary, our investments in the most developed countries in the West should be the ones we protect the most. The laws and regulations there are the most-sound, and the economy, politics, and cultures there protect investors and wealthy individuals.
However, the problem is, after you have gone there (like A’Qingsao, who ran a Chinese restaurant and did some small business), it is not enough to have the attitude of a part-time worker instead of the attitude of a boss. Don’t just buy luxury goods and airplanes, purchase the companies that manufacture the luxury goods and that make the aircraft.
More than two months ago, I went to Stockholm, Sweden, to attend an exclusive seminar on China’s economy and investment. I met Shufu Li’s Volvo partner and vice-chairman. Whether in private communication or public speaking, Sweden’s business elites, who understand China, are all happy for China to help its auto industry. They are especially delighted to use the Chinese market to revive their own, and regret that Saab is half-dead after being blocked by U.S. General Motors when it was to be acquired by a Chinese company.
The Chineses are rich and should learn more from Geely’s acquisition of Volvo and Lenovo’s acquisition of IBM. To be able to add value as a boss in foreign territory, you have to improve yourself to give others reason to obey you. This is a requirement for China’s transformation and development, and this is the direction for real transformation and development of the vibrant Chinese economy.
Guancha Net: However, frankly speaking, the vast majority of our private companies are not yet ready to go out. This aspect requires an international perspective and sufficient international talents. There is a report that 95% of overseas acquisitions in the Chinese mining sector have failed.
Yibin Li: Domestic media often publicizes that when Chinese capital buys foreign companies, there will be many restrictions in the destination country, or when it buys a company abroad, there will be many cultural obstacles during integration.
Fanchen Meng: Yes, this is indeed a big challenge. Firstly, from a national perspective, the issues we are facing are precisely the development traps that all the developing countries/region that China is learning from, including Japanese, Hong Kong, and Taiwanese companies, once faced. After having money, they did not have the self-awareness or the self-confidence to be a boss in developed countries, failing from the beginning.
If the United States wants to curb China’s rise, it must block China’s money in China, or entice it to waste its money in the markets of developed countries.
Once Chinese enterprises, entities, and even elite individuals bring money to Western Europe and the U.S., to invest in their economic activities and to become part of their vested and future interests, leaders with Cold War mentalities in the United States will be faced with the problem of denying their current operation mechanisms and free market business model. Only by self-destructing their model of a developed world can the U.S. block Chinese investment activities in their own backyard. As long as Chinese investors follow rules and regulations in developed countries, they can only be stopped by racism and discrimination. Intervention by governments into private ownership and the free market is irrational per definition and can only be justified in the name national security.
I am confident of success when it comes to organizing and regulating RMB exports. Americans can’t play against us here, because, in the current Western political and economic systems, all laws and regulations protect the interests of the rich. Moreover, the democratically elected policy is the politics of contribution. If you have money, you have the right. In addition, the total amount of China’s foreign exchange reserves is so large that if someone behind the scenes takes a long-term view, we will be invincible and succeed in whatever we do.
Despite the prevalence of protectionism in European and American companies, and although some things are not for sale, we can buy some without restriction. Chinese people are intelligent, as long as we are looking in the right direction, we can always find a way. How to do realize this is not an insurmountable problem for a Chinese nation that can look back on 5,000 years of civilization.
Additionally, you can’t just look at the failures. When we do the specific management work for first-class enterprises, we must first consult the success stories. Why was Lenovo’s acquisition of IBM successful, why was Geely’s acquisition of Volvo successful, and so on? If private entrepreneurs feel that they are not strong enough, they can join forces with state-owned enterprises, or call on the government to coordinate and organize their investments abroad.