    [Senate Hearing 114-367]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 114-367

                    EVALUATING THE FINANCIAL RISKS OF CHINA

    =======================================================================

                                    HEARING

                                   before the

                                  COMMITTEE ON
                       BANKING,HOUSING,AND URBAN AFFAIRS
                              UNITED STATES SENATE

                        ONE HUNDRED FOURTEENTH CONGRESS

                                 SECOND SESSION

                                       ON

     EXPLORING THE CURRENT STATE OF THE CHINESE ECONOMY AND THE POTENTIAL
                FINANCIAL RISKS IT MAY POSE TO THE UNITED STATES

                                   __________

                                 JULY 14, 2016

                                   __________

      Printed for the use of the Committee on Banking, Housing, and Urban Affairs

      [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                     Available at: http: //www.fdsys.gov /

                           ______

                 U.S. GOVERNMENT PUBLISHING OFFICE
     45-417 PDF          WASHINGTON : 2023

                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      RICHARD C. SHELBY, Alabama, Chairman

    MIKE CRAPO, Idaho                    SHERROD BROWN, Ohio
    BOB CORKER, Tennessee                JACK REED, Rhode Island
    DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
    PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
    MARK KIRK, Illinois                  JON TESTER, Montana
    DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
    TIM SCOTT, South Carolina            JEFF MERKLEY, Oregon
    BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
    TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
    MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
    JERRY MORAN, Kansas

               William D. Duhnke III, Staff Director and Counsel

                     Mark Powden, Democratic Staff Director

                        Dana Wade, Deputy Staff Director

        John V. O'Hara, Senior Counsel for Illicit Finance and National
                                Security Policy

                         Thomas Hogan, Chief Economist

                    Kristine John, Professional Staff Member

                   Shelby Begany,  Professional Staff Member

                Laura Swanson, Democratic Deputy Staff Director

                           Dawn Ratliff, Chief Clerk

                          Troy Cornell, Hearing Clerk

                          Shelvin Simmons, IT Director

                              Jim Crowell, Editor

                                      (ii)

                                C O N T E N T S

                                  ----------

                            THURSDAY, JULY 14, 2016

                                                                       Page

    Opening statement of Chairman Shelby.............................     1

    Opening statements, comments, or prepared statements of:
        Senator Brown................................................     2

                                   WITNESSES

    Dennis C. Shea, Chairman, U.S.-China Economic and Security Review
      Commission.....................................................     4
        Prepared statement...........................................    26
        Responses to written questions of:
            Chairman Shelby..........................................    57
            Senator Toomey...........................................    58
    Desmond Lachman, Ph.D., Resident Fellow, American Enterprise
      Institute......................................................     6
        Prepared statement...........................................    35
    Thomas J. Gibson, President and CEO, American Iron and Steel
      Institute......................................................     7
        Prepared statement...........................................    40
    William T. Wilson, Ph.D., Senior Research Fellow, The Heritage
      Foundation.....................................................     9
        Prepared statement...........................................    54

                                     (iii)

                    EVALUATING THE FINANCIAL RISKS OF CHINA

                                  ----------

                            THURSDAY, JULY 14, 2016

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 10:01 a.m., in room SD-538, Dirksen
    Senate Office Building, Hon. Richard C. Shelby, Chairman of the
    Committee, presiding.

            OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

        Chairman Shelby. The Committee will come to order.
        Today the Committee will hear testimony on the Chinese
    economy and the risks it may pose to the United States. This
    hearing comes at a pivotal time, following last month's
    Strategic and Economic Dialogue between the United States and
    China and prior to the G-20 Summit in September.
        China is currently seeking recognition by the World Trade
    Organization as a ``market'' economy rather than as a
    ``nonmarket'' economy. China is the United States' largest
    trading partner, and it has the largest banking sector in the
    world. An economic downturn in China could have a serious
    negative impact on American jobs and businesses.
        The numbers speak for themselves: In 2015, the United
    States imported $482 billion of total goods from China, and
    China imported more than $116 billion in total goods from the
    United States. In 2014, Americans invested almost $66 billion
    in China, compared to just $9.5 billion of Chinese direct
    investment in the United States.
        And, of course, China is the largest foreign holder of U.S.
    debt. And although our economic relationship with China is
    significant, experts argue that China has not followed through
    on its commitments to the United States, such as enhancing fair
    trade policies, providing greater investor protections, and
    securing intellectual property rights.
        Rather than encouraging free trade and competition, China's
    recent reforms appear to protect industries it considers to be
    strategically important.
        On the one hand, China's tilt toward free market capitalism
    has lifted many millions of its citizens out of poverty. In
    addition, since China began its free market reforms in 1978,
    the economy has grown 70 times larger.
        On the other hand, China still has a long way to go. And
    despite the success of some free market reforms, the Chinese
    government still plays a dominant role in the economy, either
    through its direct management of state-owned enterprises or its
    dictates from the central government.
        In its Third Plenum of 2013, the Chinese government
    committed to allowing the free market to play a greater role in
    the economy in order to ``rebalance'' away from investment and
    export-driven growth and toward greater domestic consumption.
        Many question the Chinese government's commitment to
    change, however. American businesses and investors recognize a
    variety of risks in the Chinese economy such as its slowing
    growth, volatile financial markets, currency policies,
    potential capital outflows, and aggressive pursuit of U.S.
    intellectual property.
        Some believe that China's economic stimulus following the
    2008 financial crisis has left the financial system with an
    unusually high percentage of bad debts. China's total public
    and private debt has almost doubled from 150 percent of GDP in
    2007 to nearly 300 percent today.
        Last year, the imbalances created by China's debt-fueled
    economic stimulus resulted in a stock market crash and an
    overnight devaluation, which caused many to rethink China's
    ability to maintain its high economic growth rates.
        These are just a few illustrations of China's risky
    policies that could lead to future crises. I look forward today
    to hearing from our panel of experts regarding the current
    state of the Chinese economy and the potential risks it may
    pose to the United States.
        Senator Brown.

                   STATEMENT OF SENATOR SHERROD BROWN

        Senator Brown. Thank you, Mr. Chairman, for holding today's
    important hearing.
        China's economy by some measures is larger than the U.S.
    economy and is very influential in global markets. But China's
    economic growth is slowing. As a result, China continues to
    make decisions to boost its economy, even when those decisions
    are not good for long-term stability and even when they violate
    international trade rules. American businesses and American
    workers suffer as a result.
        Implicit in this discussion is an acknowledgment that the
    promises made 15 years ago by the People's Republic of China
    and supporters of that country joining the World Trade
    Organization, majorities in both Houses, in this body and
    across the hall, have gone unfulfilled. China has not
    transitioned to a market economy; it has not lived up to the
    commitments it made when it joined the World Trade
    Organization.
        Instead of pursuing industrial policies that boost the
    Communist Party, China needs to make structural economic
    reforms that are good for domestic and global economic
    stability.
        For example, China needs to ``rebalance'' its economy.
    Instead of adding more production capacity, which has triggered
    massive overcapacity problems in the global markets--we know
    what that does to us--the Chinese government needs to increase
    domestic consumption and move to a more service-based economy
    to allow for more sustainable growth for their country.
        China should also reduce state ownership and state control
    in its economy. China has used state-owned enterprises to
    implement its industrial policies, but the consequences are
    sectors defined by overcapacity, by inefficiencies, by
    corruption, and in far too many cases by excess.
        A presumption of government support has allowed
    unprofitable and poorly managed Chinese companies to issue debt
    cheaply and add industrial capacity. Servicing this debt is
    getting harder as profits decline and defaults rise. According
    to the International Monetary Fund, total loans potentially at
    risk on Chinese commercial banks' balance sheets at the end of
    2015 were estimated to be about $1.3 trillion, some 15.5
    percent of the total.
        These loans are not just a risk for the Chinese government.
    They present a risk to global financial stability as well.
        We need to watch for an uptick in acquisitions of U.S.
    firms by Chinese state-owned enterprises that could pose
    national security concerns for our country. And we cannot
    ignore the fact that China has regularly intervened in its
    currency exchange rate to boost exports to the detriment of
    American manufacturers. While the yuan has appreciated in value
    recently, we know that we are just one decision away from a
    currency intervention that will hurt our business and workers.
    We know what that does, especially to States like Indiana,
    Pennsylvania, and Ohio.
        It is very difficult for American companies to compete with
    a nonmarket economy that undervalues its currency when it
    wants, uses state ownership to support companies that would
    otherwise fail, contributes to global overcapacity in major
    sectors, and follows the rules only when it suits its
    interests.
        It is also hard to compete against a country with
    persistent human rights abuses. A group of Ohioans came to see
    me at my office today from Falun Gong, talked about all the
    issues and human rights abuses that have been aimed at them and
    others. It is hard to compete against a country with
    discrimination like that against religious minorities, with
    weak labor and environmental standards, with state-sponsored
    cyber espionage, and intellectual property theft.
        If any industry knows the harm that China's nonmarket
    economy and policies can pose to our country, it is the steel
    industry and Senator Donnelly's Indiana and Senator Toomey's
    Pennsylvania and my State of Ohio. Our steel sector has
    experienced firsthand the consequences of China's industrial
    policies and competing against that country's state-owned
    enterprises.
        There is a crisis among U.S. steel manufacturers, some
    14,000 steel workers have been laid off. The crisis gets worse
    as China attempts yet again to export its way out of its
    problems, out of a slowdown.
        This is why I invited Tom Gibson, President and CEO of the
    American Iron and Steel Institute, to testify today. Steel
    workers understand the impact, his companies understand the
    impact, their workers understand the impact and risks of
    China's policies.
        That is why this hearing is so important. American
    companies and workers need a level playing field, not
    xenophobia and not cynical China-bashing. I will never do that.
    Finding real solutions to push China to change its economic
    policies, in fact, is the key.
        Thank you.
        Chairman Shelby. First, we will receive testimony from the
    Honorable Dennis Shea, who is the Chairman of the U.S.-China
    Economic and Security Review Commission and who is no stranger
    to this Committee.
        Next, we will hear from Dr. Desmond Lachman, who is a
    Resident Fellow at the American Enterprise Institute.
        Then we will hear from Mr. Thomas Gibson, who is the
    President and Chief Executive Officer of the American Iron and
    Steel Institute.
        Last, we will receive testimony from Dr. William Wilson,
    who is a Senior Research Fellow at the Heritage Foundation.
        All of your written testimonies will be made part of the
    record in its entirety. We will start with you, Mr. Shea.

    STATEMENT OF DENNIS C. SHEA, CHAIRMAN, U.S.-CHINA ECONOMIC AND
                       SECURITY REVIEW COMMISSION

        Mr. Shea. Well, thank you, Mr. Chairman, Ranking Member
    Brown, and Members of the Committee, for this opportunity to
    testify today. Before I begin, I would like to make a
    disclaimer that this testimony reflects my personal views and
    not necessarily the judgments of the U.S.-China Commission.
        Today I will focus my remarks on state control in China's
    economy and implications for the United States. Since I will be
    summarizing the key points of my written testimony, I refer it
    to you for fuller treatment of these issues.
        First, it is important to understand the extent of the
    state's role in China's economy. The Chinese government props
    up its state-owned enterprises, also called ``SOEs,'' and
    designated private firms while limiting market access for U.S.
    and other foreign firms through strict market entry criteria,
    opaque regulations, compulsory joint ventures, and China-
    specific technical standards. These policies create an uneven
    playing field that disadvantages U.S. companies both in China
    and abroad.
        Under President Xi Jinping, the government is redoubling
    efforts to increase its control over private and public
    companies in key industries. Despite repeated pledges to let
    the market play a ``decisive role'' in resource allocation,
    Beijing continues to use SOEs as a tool to pursue social,
    industrial, and foreign policy objectives. These efforts are
    evident in China's economic reform plans, which seek to help
    SOEs become ``bigger and stronger,'' not reduce the size of the
    state sector.
        The government's influence extends not just to SOEs but
    also to private companies. This is an important point. In
    testimony before the Commission earlier this year, University
    of Florida professor Wentong Zheng stated that ``the hallmark
    of Chinese state capitalism is an ecosystem in which the
    government is at the center of the economy and everybody else
    caters to the government's needs.'' In this ecosystem, public
    and private managers alike are incentivized to foster close
    ties with the government.
        Beijing primarily seeks to maintain control of strategic
    sectors that advance the state's political and economic
    interests. Economically strategic sectors, such as industrial
    producers, enable the government to support short-term economic
    growth, while politically sensitive sectors, such as
    telecommunications, are essential to the government's goals of
    advancing and controlling China's technology infrastructure and
    disseminating information.
        With Beijing's policies creating an unfair competitive
    environment both inside and outside of China, the relationship
    between SOEs and foreign companies in China has become
    particularly tense. One challenge U.S. businesses face in China
    is navigating the country's regulatory environment. U.S.
    investors have little to no recourse to protect their rights or
    fairly resolve disputes under China's opaque legal system.
        The regulatory challenges U.S. businesses face in China
    appear to be getting worse. According to a 2016 American
    Chamber of Commerce survey, 77 percent of U.S. companies
    reported they felt foreign businesses are less welcome in China
    than before.
        Market access restrictions also continue to limit the
    ability of U.S. companies to invest in China. China restricts
    foreign investment in many sectors where the United States
    maintains a competitive advantage in order to protect domestic
    companies and industry. In general, fluctuations in China's
    foreign investment restrictions follow a pattern where, at
    first, the government welcomes FDI into sectors deemed
    strategic for its national economic development in order to
    extract technology, IP, and know-how from foreign firms.
    However, after the domestic industry is judged sufficiently
    developed, Beijing issues new policies restricting investment
    to push out foreign companies and free up the market for
    domestic firms.
        Furthermore, China's government is introducing policies
    aimed to replace established market leaders with domestic
    firms. The Chinese government's latest blueprint for the
    economy, the 13th Five-Year Plan, designates sectors such as
    semiconductors, biomedicines, cloud computing, mobile Internet,
    and ecommerce for additional government support. These policies
    seek to break China's dependence on imports from foreign
    producers in sectors where the United States currently enjoys a
    technical advantage.
        Beijing, as you mentioned, Mr. Chairman, is pursuing a
    ``going out'' policy which encourages domestic companies to
    invest abroad through policy directives and subsidization. As a
    result, Chinese investment abroad, and particularly in the
    United States, has spiked. Many Chinese companies investing
    abroad receive support from state banks and capital markets in
    return for advancing state goals. And overall Chinese foreign
    investment is focused primarily in strategic sectors.
        I know my time is running out. If you give me 30 seconds, I
    will finish up.
        China has benefited tremendously from past economic
    liberalization and its close trading relationship with the
    United States. These are not abstract concepts: Witness China's
    massive trade surpluses, rising outward FDI, and burgeoning
    soft power. Several decades of economic prosperity have also
    fueled China's rapid military modernization and growing
    strategic assertiveness, most evident in the territorial
    disputes in the South China Sea and East China Sea.
        Today China's leadership seems to have forgotten the
    critical role economic reform has played in China's own success
    story, and,
    unfortunately, it seems that the Xi administration is
    tightening the grip on the Chinese economy, not letting market
    forces play a more significant role.
        I thank you for the opportunity to testify.
        Chairman Shelby. Dr. Lachman.

    STATEMENT OF DESMOND LACHMAN, Ph.D., RESIDENT FELLOW, AMERICAN
                          ENTERPRISE INSTITUTE

        Mr. Lachman. Thank you, Chairman Shelby, Ranking Member
    Brown, and Members of the Committee, for affording me the honor
    of testifying before you today. I would like to make two basic
    points.
        The first is that China's economic growth model appears to
    have run its course, and China would now seem to be headed for
    many years of very slow economic growth, much as occurred to
    Japan before it.
        The second point I would like to make is that developments
    in the Chinese economy can have a material impact on the United
    States' economic outlook. This would not be so much directly
    through China's impact on U.S. exports; rather, it would be
    indirectly through the impact that China could have on the
    global economy and on global financial markets.
        Allow me to elaborate on these two points.
        There are several reasons for concern right now about the
    Chinese economic outlook. The first is that since 2008 China
    has had a massive credit bubble that has been among the fastest
    on historical record. This has seen credit increase at a faster
    pace than that occurred before Japan's lost decade in the 1990s
    and before the U.S. housing bust in 2007. This has given rise
    to a massive degree of excess capacity in steel and
    construction as well as to bubbles in Chinese equity and
    property markets. This heightens the risk that the Chinese
    banking system will become increasingly clogged with
    nonperforming loans and with loans to zombie public sector
    enterprises, very much along the lines that occurred in Japan
    over the past two decades.
        Second, the unwinding of China's credit and asset price
    bubbles will be occurring at a highly inauspicious time for the
    global economy. Major economies like that of the United
    Kingdom, Italy, Brazil, and Japan are all likely to experience
    meaningful economic slowdowns in the period ahead, and it is
    important that we do not just look at China in isolation.
        Third, China has very poor long-run demographics as a
    result of its one-child policy, and its government appears to
    be stalling on the long-run reforms that the country so
    desperately needs to increase productivity.
        Finally, any further appreciation of the U.S. dollar could
    induce the Chinese to resort to currency depreciation. This
    risks again precipitating capital outflows out of China and
    harming trade relations with the United States. As far as the
    implications for the United States economy, as I mentioned, the
    direct impact of a slowing in the Chinese economy would not
    have a material effect on the U.S. economy. After all, China
    only accounts for around 7 percent of total U.S. exports or
    less than 1 percent of U.S. GDP. The way in which the U.S.
    economy could be materially affected by further slowing of the
    Chinese economy is indirectly through the effect that such a
    slowing might have on the rest of the world economy and on
    global financial markets. This might occur through three
    distinct channels.
        First, a slowing in the Chinese economy would have a
    significant impact on the exports of China's Asian trading
    partners and of countries like Germany, which are very much
    more dependent than is the United States on the Chinese export
    market.
        Second, China might be forced to make use of the exchange
    rate to bolster its flagging economy, especially if it
    continues to suffer from capital outflows. This could result in
    tensions in global currency markets where all too many
    countries are today seeking to cheapen their currencies through
    unorthodox monetary policy. That would risk unsettling global
    financial markets.
        Finally, a slowing of the Chinese economy must be expected
    to keep international commodity prices low for a protracted
    period of time. This has the potential to deepen the political
    and economic crisis already being experienced in commodity-
    exporting emerging market countries like Brazil, Russia, and
    South Africa.
        For these reasons, it would appear to me to be a mistake
    for U.S. policymakers to minimize the impact that a setback in
    the Chinese economy could have for the U.S. economy.
        Chairman Shelby. Thank you.
        Mr. Gibson.

    STATEMENT OF THOMAS J. GIBSON, PRESIDENT AND CEO, AMERICAN IRON
                          AND STEEL INSTITUTE

        Mr. Gibson. Thank you, Mr. Chairman, Ranking Member Brown,
    for having me here. AISI represents integrated and electric arc
    furnace steelmakers with facilities in 41 States, Canada, and
    Mexico.
        I am not going to talk so much about the macroeconomic
    risks--those are going to be well covered by others--as much as
    consequences. The American steel industry has been severely
    impacted by the surge in dumped and subsidized imports into our
    markets. Finished steel imports took a record 29 percent of the
    U.S. market in 2015, while domestic steel shipments declined by
    over 12 percent, and capacity utilization averaged just 70
    percent for the year. Several steelmakers have been forced to
    temporarily close facilities, including mills in Fairfield,
    Alabama; Ashland, Kentucky; Granite City, Illinois; as well as
    iron ore mines in Minnesota. BLS data indicates that the steel
    industry employment has declined by nearly 14,000 jobs since
    January 2015.
        This import surge results from foreign government
    interventionist policies, chiefly China, that have fueled
    massive global overcapacity in steel. That is estimated by OECD
    to be about 700 million metric tons today. More than half of
    that, 425 million metric tons, is located in China where
    government market-distorting policies have dramatically
    increased the size of its industry so that today it represents
    half of all global steel production.
        After many years of growth, Chinese steel demand has
    declined over the last 2 years and is expected to drop further
    over the coming decade. As a result, China's steel industry has
    increasingly relied on exports to consume its surplus, with
    Chinese steel exports rising to 112 million metric tons in
    2015. That is more than the 96 million metric tons of steel
    consumed in the United States last year. This has led to
    increased imports of dumped and subsidized Chinese steel in the
    United States and elsewhere. In addition, Chinese steel exports
    to third countries are being processed into steel products that
    are then exported to the United States.
        China's dramatic increase in capacity has occurred despite
    financial returns that are well below those returned by other
    global steel industries and, in fact, even other industries in
    China. China's major steel firms reportedly lost more than
    $15.5 billion last year alone, and many believe the actual
    figures are much greater.
        Nine of the 10 largest steel producers in China are state-
    owned, and the top two producers produced more steel in 2014
    than the entire U.S. steel industry. Unlike market-based
    companies, Chinese companies can run these massive debts
    because the Chinese government will often direct state-owned
    banks to continually refinance the debt and ultimately sweep it
    off the books and into asset management companies or other
    state-created financial devices or firms designed to absorb bad
    corporate debts and cover the losses.
        As we have already heard, another way China distorts
    international trade is by controlling the exchange rate between
    its currency and the dollar, and I think the other testimony
    has covered the risk of renewed depreciation of China's
    currency vis-a-vis the dollar in the future.
        We appreciate the changes that Congress made in the
    recently enacted Trade Facilitation and Trade Enforcement Act
    on currency reporting, but AISI believes the U.S. Government
    can and should take much more aggressive action on currency.
    Congress should act now on the Currency Undervaluation
    Investigation Act, which would explicitly treat currency
    manipulation as actionable under U.S. trade laws, and it has
    been championed by Senators Brown, Schumer, Sessions, Portman,
    and others.
        We also recommend the following policy actions to address
    the global steel overcapacity crisis:
        First, vigorously enforce the trade laws. It is essential
    that the U.S. Government use all means available under the
    trade laws, including fully utilizing the improvements made to
    these laws by Congress last year in the Leveling the Playing
    Field Act. Customs and Border Protection should also use all
    the tools made available to it under the recently enacted
    ENFORCE Act to prevent evasion of AD/CVD orders on steel
    products.
        Second, the Administration must also continue to treat
    China as a nonmarket economy for antidumping purposes.
    Prematurely granting China market economy status would
    completely undermine the effectiveness of our trade laws.
        Third, the Administration should seek binding commitments
    by all major steelmaking nations to eliminate current market-
    distorting subsidy programs specific to the steel sector and
    refrain from introducing new subsidy programs in the future.
        Fourth, the Administration should press for binding
    commitments from China and other countries to eliminate excess
    capacity resulting from government market-distorting policies
    and practices.
        And, finally, Congress should impose a strict prohibition
    on multilateral and export bank lending on steel projects,
    which has been a significant source of funding for unnecessary
    capacity survival and expansions.
        Thank you, Mr. Chairman, for your attention, and I look
    forward to answering your questions.
        Chairman Shelby. Dr. Wilson.

    STATEMENT OF WILLIAM T. WILSON, Ph.D., SENIOR RESEARCH FELLOW,
                        THE HERITAGE FOUNDATION

        Mr. Wilson. Good morning. My name is Bill Wilson. I am an
    Economist, a Senior Research Fellow at the Heritage Foundation.
    And although I have spoken many times in public over the past
    quarter century, this is my first time in front of a
    congressional Committee. I appreciate the Chairman for inviting
    me today.
        I lived abroad for 7 years. I lived for 4 years recently in
    Beijing. And when I arrived last year, my colleagues asked me
    whether I had ever testified on the Hill, and I replied, ``What
    hill?''
        [Laughter.]
        Mr. Wilson. And they laughed, not knowing that I did not
    actually know. But it is a pleasure to be here.
        Again, the views I may express may not necessarily reflect
    the official position of the Heritage Foundation. I am going to
    keep my comments extremely brief, maybe about 3 minutes,
    keeping time for questions.
        In short, China, in my opinion, is in trouble. There is a
    cancer in the economy, and it has metastasized. Recently,
    headline figures have conveniently matched Beijing's target
    figures of 6.5 to 7 percent. Here is an economy with 1.4
    billion people, and they released GDP figures 14 days after the
    end of the quarter, and there are no revisions.
        There are plenty of inconsistencies. While GDP was reported
    as 6.8 percent in 2015, electricity consumption rose by only a
    half a percent. These two figures are simply not consistent.
        As Chairman Shelby had mentioned in his earlier comments,
    if you look at China's total debt--I am talking about
    household, corporate, government debt, including provincial
    debate--it is now much higher than in other developing
    economies and actually comparable to levels in the United
    States and the eurozone which have much higher levels of a
    stock of wealth.
        Where the concern, though, is, what is more troubling is
    the speed at which debt has accumulated. It was approximately
    150 percent of GDP in 2007, a year before the crisis, and now
    it ranges between close to 300 percent of GDP. These are
    enormous figures.
        Since the 2008-09 global recession, China has accounted for
    roughly one-third of global economic growth, by far the highest
    in the world. With a gross domestic product of roughly $100
    trillion, measured at market prices, the second largest economy
    in the world after the United States, any economic slowdown in
    this Asian juggernaut is bound to have global economic
    consequences.
        Since 2010, the rate of economic growth in China has
    decelerated from 9.3 percent in 2011 to a reported 6.8 percent
    in 2015. And the accuracy of this latest figure is in serious
    question.
        I will finish by saying the question is: What is the impact
    of a further slowdown in China on the U.S. economy? There are
    three primary channels in which a significant slowdown in China
    could impact the U.S. economy. The first, of course, is through
    trade. In 2015, China was America's third largest export market
    after Canada and Mexico, respectively. The value was $116
    billion. Exports to China accounted for about 7.7 percent of
    total U.S. exports in 2015, not an inconsequential figure but
    not devastating to U.S. export revenue in the event of a
    further stall in Chinese growth.
        The second, of course, is financial. As also Chairman
    Shelby mentioned, the Chinese, as of the latest figure, April
    2016, replaced the Japanese as the largest holder of U.S. debt,
    at $1.2 trillion.
        In the event of a further slowdown in the Chinese economy,
    the government may want to sell some of these securities for
    economic stimulus. This could lead to a fall, of course, in
    U.S. bond prices--i.e., a rise in U.S. interest rates. This
    impact has been discussed extensively and largely exaggerated
    for two reasons. First, the Chinese are unlikely to liquidate a
    large portion of their U.S. Treasury holdings because it might
    lead to a capital loss on their existing holdings. Second, U.S.
    Treasuries are the most liquid and most coveted securities in
    the world.
        I know I am running out of time. Give me 15 more seconds.
        Chairman Shelby. Take your time.
        Mr. Wilson. And the last channel is largely a positive one.
    The slowdown in the Chinese economy has significantly depressed
    global commodity prices. Despite the shale revolution that we
    have witnessed the past 5 years, the United States imported 9.4
    million barrels of petroleum per day in 2015. So the net impact
    for the U.S. economy was positive.
        I will finish here.
        Chairman Shelby. Thank you.
        I will start with you, Dr. Lachman. In your testimony, you
    say that China's pace of credit expansion in recent years,
    which you refer to as a ``credit bubble,'' exceeds those that
    have preceded other major crises like the Asian financial
    crisis and the U.S. housing crisis. A couple of questions here.
        Is it possible that this credit bubble will lead to a
    financial crisis in China? And what would be the potential
    impact on the U.S. economy? Dr. Wilson alluded to it a minute
    ago.
        Mr. Lachman. The credit bubble in China has no precedent
    elsewhere. This is far larger than it has been in many other
    countries, and those countries that have had those sort of
    bubbles have all run into deep trouble.
        Now, there are two kinds of trouble that countries can run
    into. One is you can have a financial crisis like we had in the
    United States with Lehman spreading through the global economy.
    The other--and that I think is the more likely outcome--is you
    can have a Japanese situation in which, because you have got
    real problems in the financial sector, the economy becomes
    highly sclerotic. It gets clogged with loans who prop up some
    big companies, and it really just loses its dynamism.
        My belief is that China is going to go the second course,
    the Japanese course, mainly because China's economy is very
    different from that of a regular economy in that the state
    controls both the banks and it controls the state enterprises.
    So what it is likely to do in the event that there is somewhat
    of a meltdown is they will instruct the banks, as they seem to
    be doing now, to continue lending to these companies, to
    continue piling up the debt.
        So I do not expect to see a sharp disruption in China, but
    I do expect to see China's economy slowing. And as I mentioned,
    one has to be viewing that in the context of the rest of the
    world. Europe does not look healthy. Japan does not look
    healthy. A number of major commodity-producing countries do not
    look healthy. To have China slowing could just add to a global
    environment that is not very helpful to the United States.
        Chairman Shelby. Thank you.
        Dr. Wilson, you described China's level of debt as
    ``unprecedented and unsustainable.'' Explain that. And what are
    the potential dangers of such high levels of debt?
        Mr. Wilson. Yes, if the last 7 or 8 years have taught us
    anything in the United States, it is, you know, the
    consequences of excessive leverage. If you look at the U.S. GDP
    numbers, the U.S. economy, because of the excess leverage that
    we experienced over the last 15 years, has grown--the U.S.
    economy has grown less than 3 percent for 9 consecutive years
    as a result of deleveraging. If you go back to the Bureau of
    Economic Analysis and look at the numbers and go way back to
    the Great Depression, you will not find a period of such slow
    protracted growth.
        I know this: I worked as a banker, as a bank economist, for
    9 years, and the economic stimulus package that Beijing passed
    in 2009 was a mother of all stimulus packages. It amounted to
    20 percent of gross domestic product. I know this as a banker:
    If you lend out that much capital over a short period of time,
    most of the loans will go sour. There is no doubt about it.
        Chairman Shelby. It is throwing money at a problem, isn't
    it?
        Mr. Wilson. Exactly. That is what you do. The CCP, the
    Chinese Communist Party, their major concern, of course, is
    maintaining power. There is a quid pro quo. They deliver the
    goods--that is, growth in excess of 7 percent, full employment,
    in excess. The Chinese give up, you know, political freedom.
    That contract could expire very shortly.
        How fast is the Chinese economy growing? I do not know
    exactly. We do not have reliable figures. But it is not 6.8
    percent. It is probably more in the range of 4.5, 5 percent.
    And so this is not a sustainable equilibrium.
        Do the Chinese have further room to add debt? They do. They
    do. They could leverage up to 400 percent of GDP over the next
    2 to 3 years. But after that, time expires. It is not a
    sustainable equilibrium.
        Chairman Shelby. How do you deleverage something like that?
    Isn't that a question? If you are up to 400 percent, if you got
    that high, then you are going to have to deleverage that
    someday, aren't you?
        Mr. Wilson. Yeah, as a former banker, people say, well you
    just write off debt. Well, if you write off--you simply do not
    write off debt. Someone pays for it. Either the lender or the
    borrower or, increasingly, the taxpayer pays for that writeoff.
    It does not disappear. It does not disappear from the balance
    sheet.
        Chairman Shelby. It is consequences, isn't it?
        Mr. Wilson. Exactly.
        Chairman Shelby. Currency devaluation, we have talked about
    that here, too. A recent article in The Economist magazine
    noted, and I will quote, that ``A mere 2 percent devaluation of
    the yuan last summer sent global stock markets crashing; a
    bigger bust would do far worse.''
        Is it possible that an economic downturn in China could
    lead to similar events in the future? And what would be the
    impact on the United States? Dr. Lachman, I will pose that to
    you. I know I am not picking on you.
        Mr. Lachman. I think that the risk of another currency move
    in China is very real. That is not simply because what you are
    getting in terms of a slowing Chinese economy, that they might
    need to use that to get a further leg up on the export
    competition that they are so good at. But it is rather because
    what another devaluation can do, is it can really cause capital
    to leave China.
        Now, the reason that one has to be concerned that China
    might resort to this is that the dollar could very well
    appreciate, as it is doing right now, because you have had
    Brexit and stuff of that sort. As the dollar appreciates, the
    Chinese might want to depreciate their currency against the
    dollar, and that is, in fact, what we have been seeing the last
    couple of weeks.
        So one really cannot exclude that China is again going to
    be depreciating its currency, not necessarily against a basket
    of all currencies but certainly against the U.S. dollar in the
    context of the U.S. dollar strengthening, and that can have
    consequences like The Economist noted. Last August, we saw
    ripples going right through the global financial system because
    of a 2-percent move in the Chinese currency. So one really
    cannot exclude that from occurring again going forward.
        Chairman Shelby. Chairman Shea, the National Strategy for
    Critical Infrastructures and Key Assets adopted following the
    9/11 attacks emphasized that the fundamental need for food as
    well as great public sensitivity to food safety makes assuring
    the security of food production and processing a high priority.
    In your opinion, can the concerns regarding U.S. food security
    be adequately addressed by the current review processes,
    including those of the Committee on Foreign Investment in the
    United States?
        Mr. Shea. Well, I am reminded by what Senator Grassley
    says, we are nine meals away from a revolution here in the
    United States. If you do not get nine meals, people are going
    to be very unhappy. The Chinese obviously consider food----
        Chairman Shelby. Would it take nine meals?
        Mr. Shea. Nine meals, that is what Senator Grassley said,
    so I kind of stick with him. But, yes, I think food security
    should be an issue. I support efforts to include the Department
    of Agriculture as part of the CFIUS review of transactions
    affecting U.S. companies in the agricultural area. So I think
    that is a valid point. So I think food security is something we
    should pay attention to in the United States. I do not think
    any Chinese transaction currently threatens, or any other
    transaction from any other foreign company threatens, U.S. food
    security. But I think it definitely is a concern that should be
    taken into account in the CFIUS process, and the Department of
    Agriculture ought to have a seat at the table.
        Chairman Shelby. Thank you.
        Senator Brown?
        Senator Brown. I am still pondering what nine meals and
    revolution. That is something with the Great Leap Forward or
    something.
        Dr. Wilson, congratulations on your first testimony. Nice
    work so far.
        Mr. Wilson. Thank you.
        [Laughter.]
        Senator Brown. Mr. Gibson, I want to start with you.
    Witnesses have commented on the current state of the Chinese
    financial system. We make a mistake, I think we all know that,
    if we look at it as a system in the same sense of our own
    financial system or like that of other market economies since
    the most important element of the system, their system, is
    government.
        Discuss, if you would, Mr. Gibson, how much Chinese banks
    lend to the steel industry. Is it increasing? Do you know how
    many of these loans are at risk of default? Would China let
    their state-owned enterprises default on these loans? Talk that
    through so we understand better.
        Mr. Gibson. You know, as far as the risk, it is a little
    bit hard for me to evaluate. The borrower and the lender are
    the same entity eventually at the top. We have data that
    indicates among the largest Chinese steel companies, they have
    accumulated a debt ratio of about 71 percent and about a half
    trillion dollars of debt.
        We know from public sources that the reported losses last
    year for the Chinese steel industry were $15.5 billion. The
    financing is one of the advantages that the Chinese state-owned
    steel industry has, and it enables it to keep the zombie
    enterprises that have already been talked about in business. It
    allows these entities to keep operating, keep producing steel,
    and keep pumping that into the market. So the financing aspect
    of it, the public ownership of financing, the policies of the
    People's Bank of China with respect to the steel industry,
    which anyone can pull off the Web and read, which are to
    encourage, support, and promote the steel industry, including
    promoting the steel industry's directive from other parts of
    the Chinese government to seek capacity abroad to replace
    closed capacity in China, all those are part of the problem
    that are feeding this overcapacity issue.
        As far as the risk of the loans, I think I would let others
    talk about the risk of these loans. They would be highly risky
    loans in a market economy, but, again, since the lender and the
    borrower ultimately are the same person, pretty hard to
    quantify risk, what their risk tolerance is.
        Senator Brown. Let me take that further. You have obviously
    talked about overcapacity. What steps does China need to do to
    live up to its previous commitment to reduce overcapacity in
    the industry? And how do we get China to take these steps?
        Mr. Gibson. I think China needs to see resolve. In order to
    get China to act, China would probably rather not discuss
    overcapacity at a Strategic and Economic Dialogue or at a G-20
    Summit. They are being forced to. Why are they being forced to?
    Well, in the United States our industry is using the trade
    remedies available to it under the trade laws to bring trade
    cases. China in most cases is choosing not to defend those. So
    we are acting domestically using the laws, and the improvement
    in the laws has enhanced our
    ability to make the cases in a timely way and to be able to get
    good margins in cases where the Chinese do not even supply
    data.
        So we have to use our laws. We have to engage in diplomacy,
    and I think you saw that coming out of the G-7 Summit where the
    issue of overcapacity in steel and other industries was one of
    the leading topics discussed. It was also one of the leading
    topics discussed at the S&ED. The Chinese were forced to
    confront that.
        Now, the Chinese have plans, and they have had plans
    before. I have got a list here I could supply for the record of
    the various Chinese steel capacity reduction plans. They have
    been aware of this problem since the middle of the last decade.
    They have repeatedly issued plans to address overcapacity. And
    at each step, capacity has increased. They claim credit
    sometimes for a capacity reduction due to one of their last
    plans, 90 million tons. The State Council claimed credit for
    that between 2011 and 2015. In fact, their capacity increased
    by over 300 million tons. They do not use the word ``net.''
    They may have closed 90 million tons of obsolete capacity
    somewhere. Their net capacity has increased.
        So we just have to continue to use the trade remedies that
    are available to us. As we are using them, that steel is
    finding homes elsewhere because their exports to the globe, to
    the rest of the world, are actually increasing, up 20 percent
    last year, and now seemingly going to be up again this year. So
    others need to look to their own trade remedies, and we need to
    continue using trade diplomacy and forcing China to confront it
    and follow through on these commitments.
        Senator Brown. OK. I would like to hear from the others on
    that same question. What do we do? What do we do to get China
    to take the needed steps to reform the economy? Obviously,
    policymakers--from ITC, the Department of Commerce, to us on
    this panel--need to show resolve with China. But, Mr. Shea, if
    you would, and then Dr. Lachman and then Dr. Wilson, your
    thoughts on that.
        Mr. Shea. I think the conundrum is that there are people in
    the Chinese leadership who understand what needs to get done to
    get their economy on a more sustainable path, reducing
    overcapacity, moving away from an export-led, infrastructure-
    led economy, to one more focused on domestic consumption.
        The problem is making those changes can be very painful to
    the Chinese people. If you are laying people off in steel,
    hundreds of thousands of people potentially in these steel
    mills and other industries with overcapacity, other steps that
    need to be taken could be very painful.
        So what the Chinese--the key thing for the Chinese is the
    primacy of the Communist Chinese Party and the preservation of
    their power. So the leaders say, many of them, OK, we need to
    go this way, but the pain is so great, in the short term it
    could be destabilizing to them. And so I have to say I am
    pessimistic that the Chinese government, based on the desire to
    preserve domestic stability, in the short term at least, will
    force them to make the necessary changes.
        Senator Brown. Dr. Lachman?
        Mr. Lachman. I very much share Mr. Shea's view that this is
    not at all an easy process for the Chinese. The point is that
    the
    Chinese have allowed their economy to become hugely imbalanced;
    that if you look at the Chinese--just to quote one statistic,
    China has been investing something like 45 percent of its
    product, and its whole model has been this investment-led,
    export-led kind of model. To shift away from that, to bring
    that down to something like 30 percent is a huge undertaking,
    and it seems that the knee-jerk reaction--they said that they
    were going to do it at the end of last year, but the first
    quarter, what we saw is we again saw a massive increase in
    credit to keep the enterprises alive and not to do anything
    about the excess capacity problem.
        So I know am afraid I share the pessimism that you are not
    really going to get much out of the Chinese.
        Senator Brown. Thank you.
        Dr. Wilson?
        Mr. Wilson. Yes, I have to say the level of excess capacity
    in many basic industries is a serious problem right now in
    China--steel, cement, oil refinery, even solar panels. The
    Chinese Communist Party is essentially between a rock and a
    hard place. I remember when I bought my first apartment, I
    actually painted myself into a corner. I guess I am not that
    bright. I think the CCP has done essentially the same thing.
    They have essentially two options. They have two options. The
    biggest engine of growth in the Chinese economy has been fixed-
    asset investment. It has been running 45 to 50 percent of gross
    domestic product. No other country in the world is experiencing
    these levels. Even South Korea, Hong Kong, Taiwan during their
    great growth periods in the 1960s and 1970s never had fixed-
    asset investment at 50 percent of gross domestic product.
        I am also a mathematician, too, so if you look at the math,
    to bring that down to a more sustainable level--in other words,
    to reduce the excess capacity to, let us say, 30 percent of
    gross domestic product--ensures basically a financial crisis, a
    strong macroeconomic contraction. And so the Chinese
    authorities have two choices. They can continue--by the way,
    one more thing. Credit growth in China in the first quarter
    grew at its fastest pace since the 2009 stimulus package. So
    they are still growing the credit. So if they can cut back,
    have the recession now, or wait a few years, and it can be a
    lot worse. Those are essentially the two choices.
        Senator Brown. Let me ask in closing one just yes-or-no
    question, starting with you, Mr. Gibson. Should China be
    granted market economy status?
        Mr. Gibson. No.
        Senator Brown. OK. Mr. Shea?
        Mr. Shea. No. If you look at the statutory obligations for
    market economy status, Chinese does not--there are six points.
    China does not meet most of those points.
        Senator Brown. Dr. Lachman?
        Mr. Lachman. No.
        Senator Brown. Dr. Wilson?
        Mr. Wilson. No. Especially since 2002, it has been a state-
    led capitalistic economy. I would not grant its economy that
    status.
        Senator Brown. OK. Thank you.
        Chairman Shelby. Senator Heitkamp.
        Senator Heitkamp. Thank you, Mr. Chairman, and thanks to
    the Ranking Member for holding this hearing. And I want to
    thank the panel of experts. I think this is a critical issue,
    not because we worry so much about the Chinese economy, but we
    worry about the effect of the Chinese economy on the economy of
    the world and certainly the economy of the United States.
        And so over the past 12 months, I have watched market
    volatility rise and fall and being affected by speculation, one
    would argue, but certainly by concerns about what is happening
    in the Chinese economy.
        I asked Assistant Secretary for International Finance
    Toloui to come into my office and talk about the Chinese
    banking system, and from Treasury's perspective, what are the
    risks, where do we think we are right now, and what are we
    looking at. He did a great job, I think, kind of running
    through the paces on where we are right now, what the concerns
    are, and honestly saying, you know, this is a situation that
    needs to be watched but do not press the panic button yet.
        So I want to ask a couple questions about where we are
    right now in terms of our evaluation of the Chinese economy, of
    the potential credit bubble, and what that means for the
    American economy, and then also, you know, what we cannot see.
    We see the institutional kind of structure that we are allowed
    to look at, but we have got the whole concern about what is
    happening with shadow banking and what is happening with what
    we cannot see.
        And so I guess my first question would be for anyone on the
    panel. You know, the Chinese government has made commitments to
    be more transparent and to improve kind of their financial data
    and financial reporting. How many of you believe that China
    will actually follow through on those commitments, that we will
    actually get better data as a result of that commitment? And
    then, second--because I think I know your answer already--what
    are the secondary tools that we can, in fact, utilize that will
    give us better data and better insight on what is actually
    happening institutionally with Chinese lending? I would just
    start here with Mr. Shea and work down the row.
        Mr. Shea. Well, you have heard about the credit bubble,
    close to 300 percent of GDP. Shadow banking is a concern.
    Transparency, greater transparency, that is something that the
    Chinese Communist Party is not really too keen on, so I would
    not be optimistic on seeing a tremendous amount of greater
    transparency.
        Let me just make a point that has been raised, if it is all
    right. It relates to your question. This China-America thesis
    that the Chinese and the American economies are so interrelated
    that they are one and the same thing, that is not true. China
    is not America's banker. Please do not say that. This----
        Senator Heitkamp. I do not think I did.
        Mr. Shea. I know, but I have heard----
        Senator Heitkamp. In fact, I think if you had Treasury
    here, you would hear exactly that, that this has been
    overexaggerated in terms of the risk to the American economy.
    But it still needs to be watched.
        Mr. Shea. Right.
        Senator Heitkamp. My question is--you know, I think we all
    agree that we are not going to get transparency. The question
    is: Short of actually getting data that we can rely on from the
    Chinese government, where do we go to actually have a deeper
    and better understanding of what is happening with credit in
    China?
        Mr. Lachman. That China's not transparent certainly is very
    clear, that it is not just a question of the banking
    statistics, as has been mentioned before in terms of their
    whole GDP numbers. All of this seems to be rather fictional.
    You know, I very much agree that China is not growing at 6.7
    percent. It is, rather, growing at something like 4 percent. I
    would think that these problems are very deep-seated, that they
    are serving a Communist Party that is wanting to stay in power
    that does not really have an interest in transparency. And the
    problem might be that they have got control over the banking
    system in a way other countries really do not.
        Senator Heitkamp. I think we all understand--I do not know
    if I am just being too opaque here, like the Chinese, but what
    I am trying to get at is we do not believe and I do not believe
    that we will get reliable data from the government, and the
    government right now is a source of information. What are the
    other sources of information that we can utilize to better
    evaluate? You know, you are speculating on what the actual
    gross domestic product is of China. Why should we rely on your
    4? Why shouldn't we believe it is potentially 2 or 1.5?
        Mr. Lachman. Right, well, if one has to do this privately
    and one has to do this indirectly, you are going to have a
    range of estimates. So basically what people are doing is they
    are trying to figure this out from various indicators. Instead
    of looking at GDP as it should properly be put together, what
    they are doing is they are looking at electricity consumption,
    credit expansion, tourist traffic, rail freight, and so on, and
    trying to pull it up from the ground. But you are really only
    going to get indications that the official numbers are very----
        Senator Heitkamp. Doctor, do you think that is complicated
    by shadow banking, by--you know, we do not really know what the
    complete credit picture is because we do not know--
    historically, I would imagine there has been a lot of shadow
    banking. That has been traditional methods of funding capital
    or moving capital that could be below the rate or even for the
    government. And so the question is: How much risk do you think
    we have in shadow banking?
        Mr. Lachman. Certainly, in China there is considerable
    risk. We know that the shadow banks have been very active in
    extending credit, and this would be a problem in a country that
    was not run by the Communist Party, you know, to have shadow
    banks----
        Senator Heitkamp. Well, we have shadow banking.
        Mr. Lachman. Correct. If that is not properly regulated,
    you can really run into difficulties on that score. That is a
    source of concern. But as I----
        Senator Heitkamp. Do you agree with Mr. Shea that we have
    overexaggerated probably in the media more than any place the
    interconnectivity between the American economy and the risks to
    the American economy from Chinese bubbles?
        Mr. Lachman. Well, the risks might be there, but what I
    would just note is that last year what occurred is because of
    capital flight out of China, China reduced its Treasury
    holdings by a fair amount. It reduced its international
    reserves from something like $4 trillion to $3 trillion. There
    was a decline of $1 trillion in their international reserve
    holdings, and the world did not come to an end. You know, so
    the notion that they can really disrupt our markets, you know,
    would seem to have been tested last year.
        Senator Heitkamp. I am out of time, and so I will probably
    submit some questions for the record. But I just wanted to make
    sure that we got the point.
        Mr. Shea. Brookings Institution has done some work on
    Chinese shadow banking, and the work I have read indicates that
    they do not think it is that big a concern in China. So we can
    get that for you.
        Chairman Shelby. Senator Menendez.
        Senator Menendez. Thank you, Mr. Chairman.
        There are many disadvantages to American businesses with
    respect to China's market barriers, its impediments to
    competition, lack of transparency, state monopolies, government
    subsidies, currency manipulation, discriminatory industrial
    policies, restrictions on trade and distribution rights, the
    lack of intellectual property protections. So as of March of
    this year, the United States has bought 17 WTO dispute
    settlement cases against China on cases in each of these issue
    areas. Clearly, we have identified many areas of disagreement
    with China.
        My question is: Is there any evidence that WTO actions or
    any other actions have actually changed China's policies or
    behaviors? And if the answer to that is no, then what, in fact,
    should we be doing beyond our WTO objections? Does anyone have
    an opinion on that? Mr. Shea?
        Mr. Shea. Well, the WTO process is costly, not necessarily
    accessible to small- and medium-sized businesses in the United
    States. It takes a long time. And even after favorable
    decisions by the WTO in the interest of the United States,
    sometimes the Chinese do not abide by what the decision was.
    And I am thinking of the distribution of movie rights, movies
    into China, as one specific example.
        So I think the system is effective to some degree, but it
    is certainly not a satisfactory system for responding to all
    the things that you just listed as problems in our trade
    relationship.
        Unfortunately, this is something we struggle with on the
    Commission, is to how to come up with sort of effective
    responses. One thing, I think the USTR, for example, should
    initiate cases. Sometimes companies are afraid to come forward,
    and the USTR should initiate cases if they feel the national
    interest is being jeopardized. I think companies are subject to
    forced technology transfers, and I think we ought to look at
    the antitrust laws to allow U.S. companies, as long as their--
    in addition to other Western companies--to talk to each other
    about, you know, we are not about resisting these forced
    technology transfer and other requirements without having to
    worry about whether they are violating the U.S. antitrust laws.
        So my testimony lists a few other things. I think
    multilateral action is always much more effective than the
    United States going alone, so working with our allies. One idea
    I heard recently was to create a Department of Trade
    Enforcement within the Justice Department. The USTR negotiates
    trade deals, but maybe put a trade enforcement function within
    the Department of Justice. That is an idea that I have heard
    raised.
        Senator Menendez. Mr. Gibson?
        Mr. Gibson. Thank you, Senator. I would say that was one of
    the reasons it was so important to get the trade law
    improvements last year, because those are tools that are in our
    control to use to bring the cases. The changes help.
        Another thing that helps is increased resources for trade
    enforcement, and the Appropriations Committee made additional
    resources available last year to enforce these new laws that
    were passed last year and is even thinking about putting a
    little bit more money toward that this year.
        So that is our other option, is to use the trade laws and
    to bring cases and to enforce the trade laws where we find
    violations.
        Senator Menendez. On the Finance Committee, I raised this
    issue about it seems to me that the burden is
    disproportionately put on private companies to be the
    prosecutor of violations of international agreements, when it
    should be the Government. Companies could provide information
    to the Government in order to make that analysis and then have
    the Government be the one to prosecute the violations and not
    have the burden on the private sector and/or steelworkers or
    others to try to prove what is going on. So I look forward to
    continuing to pursue that line of opportunity because to the
    extent that there are going to be trade agreements, one of the
    undermining elements of it is that there is a lack of
    enforcement. So what good is an agreement but for the ability
    to enforce it and the rule of law to be able to ultimately
    pursue your differences.
        Let me ask this question: There are some who suggest that
    our two economies--the United States' and China's--are so
    intertwined that failure for one means failure for another, and
    I think some of you have touched upon these remarks. I often
    hear from people running for office that China has a powerful
    tool against us, which is their $1.2 trillion large-scale
    investment in U.S. financial assets, and that a disinvestment
    of China in that regard would be catastrophic.
        Under what scenario would it be possible that China would
    decide to suddenly and significantly reduce their liquid U.S.
    financial assets? And if they were to do that, isn't there a
    very significant consequence to them as well? Dr. Lachman?
        Mr. Lachman. Well, as I mentioned, we saw something like
    that last year. You saw a circumstance in which China reduced
    its international reserves by around $1 trillion because they
    had a huge amount of capital outflow, yet it did not seem to
    have much impact either on United States interest rates or on
    the United States dollar. So I am not sure that I see this as a
    very effective weapon, and there is also the point that using
    that kind of weapon might not be in your own interest, you
    know, to be dumping Treasury bills at a loss. So I am not sure
    that I see this as something that we really need to be too
    worried about. What we do need to be worried about more is the
    continuation of the imbalances in China and what that might
    imply for the global economy. You know, if those imbalances get
    even more out of line, the disruption could be very large to
    the United States economy.
        Senator Menendez. One final question, Mr. Gibson. If China
    through its illegal dumping subsidies and continued growth of
    capacity is allowed to decimate the U.S. steel industry
    further, what is your prediction for the shape of the U.S.
    industry? And how long does the industry have before the United
    States could be dependent on other countries for its
    infrastructure and defense needs?
        Mr. Gibson. Well, you know, the situation right now is
    quite dire. The damage done to the industry has been extreme
    over the past few years. We have seen this once before recently
    in the decade beginning in the end of the 1990s, late 1990s
    into the 2000s. We saw a restructuring of the U.S. steel
    industry, 33 bankruptcies. We went from 46 steel-producing
    companies to 29 steel-producing companies. You only have to
    look out your right window driving up I-95 when you go through
    the Harbor Tunnel and look at what used to be the largest steel
    plant in the world at Sparrows Point, which is no longer there.
    It is gone.
        So over the long term, we need to get a remedy to this, and
    the industry is availing itself of the remedies as under U.S.
    law. And that can deal with imports from China into the United
    States.
        Unfortunately, China has not reduced its capacity. It is
    continuing to produce at a high level, even as its own demand
    decreases, which means it is pushing out more into the world
    market, which is displacing steel in other countries, making
    them look to a market such as the United States. So we need to
    be on this right now. It is an immediate problem.
        Senator Menendez. Thank you.
        Chairman Shelby. Senator Warren.
        Senator Warren. Thank you, Mr. Chairman, and thank you all
    for being here today.
        The data show that China's economy is caught between a rock
    and a hard place right now. Since the 2008 crisis, it has
    relied on massive amounts of debt to finance its ambitious
    growth targets, but now the debt has lurched out of control. A
    decade ago, China's debt relative to its GDP was about 150
    percent. Today that ratio is 260 percent. And the payments are
    coming due on this.
        I understand that now 40 percent of all new debt goes to
    making interest payments on old debt. So it is more and more
    debt before they even get any growth in this.
        The number of delinquent loans has doubled in just the past
    2 years, and these are all classic signs of a credit bubble
    about to burst.
        So China appears to have two options: it can cut back on
    credit and let current economic growth sag; or it can keep
    pumping more debt into the economy, propping up the growth now
    but setting the stage for a bigger crash down the line. The
    impact on the global economy and the U.S. economy will depend
    in part on which of these two paths that China takes.
        So, Mr. Shea, can I start with you? Which path do you think
    China is going to take on this?
        Mr. Shea. I think they are going to take the path of least
    resistance. I think they are going to take the path that in the
    short term they perceive as being in the interest of the
    Chinese Communist Party staying in power, which means making
    sure that people are relatively happy and not losing their
    jobs, not suffering.
        So I think, again, they know what needs to be done. They
    are doing some steps on the debt. They are securitizing some of
    the debt. They are creating, you know, companies to offload
    some of the nonperforming loans, which they did this 10 years
    ago. They created asset management companies that were
    basically zombie companies that took all this debt. They are
    experts at pushing the problem down the road further and
    further. They are really good at that.
        But, again, the point is that they know what needs--many of
    them know what needs to be done, but the pain in the short term
    is so hard that they are concerned that it is going to
    jeopardize the stability of the country and the primacy of the
    Chinese Communist Party. So that is----
        Senator Warren. So you think they will just continue to----
        Mr. Shea. I think they will muddle along. I think they are
    going to muddle along.
        Senator Warren. All right. Well, let me ask about this,
    because I want to dig in just a little bit on this. We have
    already talked about a little bit that the experts cite data to
    show there would be fairly modest direct harms to the U.S.
    economy from a slowdown in the Chinese economy. And you have
    already talked about it here this morning. And most of the
    people who talk about this note that U.S. investors have very
    little money directly in the Chinese stock markets. According
    to some expert analysis, U.S. exports to China make up only
    about seven-tenths of a percent of our GDP. So the general
    impact, it seems there is some consensus around the notion that
    the general impact to our economy if China starts--whether it
    is in the very short term or down the line starts down, it is
    not going to be as severe for us.
        But I want to dig in a bit more on the exposure of our
    financial sector to the Chinese economy and specifically to its
    banking system. After all, it is China's banking sector that is
    the world's largest, yes, larger than the United States, with
    total assets equal to about 40 percent of the entire global
    economy. And while investors here at home may not have
    significant direct investments in Chinese companies, there are
    other ways that we are exposed. You talked recently about the
    impact of disinvestment and said it has not had the big impact
    we expected. But big banks and financial institutions in the
    United States are certainly exposed through derivative trading
    and other financial interactions to sharp changes in commodity
    prices and currency valuations that would result from any
    turmoil in the Chinese market.
        So, Mr. Shea, if the Chinese credit bubble pops, whether it
    is sooner or later, dragging the Chinese economy down with it,
    what kinds of vulnerabilities might we see in our U.S.
    financial services industry?
        Mr. Shea. Well, I was going to kick that over to Dr.
    Lachman----
        Senator Warren. Well, I am going to Dr. Lachman next, so it
    is entirely up to you.
        Mr. Shea. Yes, I think it is the financial sector that is
    probably the most exposed to the Chinese economy. You correctly
    point out they do not own as much Treasury debt as we say--as
    commonly believed. There are--not a significant portion, I
    think 7 percent of U.S. exports are to China. The FDI between
    the two countries is quite minimal as a percentage of global
    FDI, of U.S. FDI to China, Chinese FDI to the United States. So
    we are not as intertwined as commonly believed. As has been
    pointed out before, there are second-order effects. Other
    economies in the world are very intertwined, particularly
    commodity-exporting economies like Australia and Brazil are
    very intertwined with the Chinese economy, much more so than
    ours, and as a result, our relationship--if those economies go
    down, then we get affected as well. But that is a second-order
    effect.
        I am going to turn it over to Dr. Lachman.
        Senator Warren. Dr. Lachman? I was coming to you anyway to
    ask about this question about what happens with the largest
    financial institutions in the United States and their exposure
    on derivatives and other financial transactions.
        Mr. Lachman. Well, the way I think about it is, firstly, I
    would say that it is very unlikely that you are going to get
    the bubble bursting in the way that occurred in the United
    States because they have got control over the banks, they have
    got control over the state enterprises. They are going to be
    just pumping in credit to keep zombies alive, you know, much
    like what Japan did.
        So, for instance, if you look at what happened in China at
    the first quarter of this year, while the government realizes
    that they do have to transform their economy, that did not stop
    them from increasing credit by something like 40 percent, the
    fastest rate that they have done, you know, repeating those
    practices. So it seems unlikely to me that you are going to get
    the bubble bursting.
        Where you could get an impact on the United States
    financial system and on the United States economy is through
    the impact that China would have on the global economy, that
    China is the second largest economy right now, has been
    providing most of the growth, and at a time that we have got
    real trouble in many other economies around the globe. I am
    thinking of a place like the U.K. now, Italy, Brazil, Japan,
    and emerging markets. A Chinese slowing is the last thing that
    you are really wanting to do.
        So I do not think that one should be complacent about the
    impact that this might have on the United States banking
    system, but I do not see the impact as being through direct
    exposure of United States companies.
        Senator Warren. So you are not worried about the exposure
    through derivatives that, for example, put our banks deeply
    engaged on the question of commodity prices or other financial
    transactions more directly?
        Mr. Lachman. Oh, absolutely, I would be concerned about
    that. But it is not to China itself. It is, rather, through
    China's impact on world commodity prices, China's impact on the
    outlook for other countries that are struggling to get their
    economies going. Then, you know, the United States banking
    system is hugely exposed, for instance, to Europe. So, you
    know, if Europe going through its problem with Brexit or having
    trouble likely to occur with the Italians, their referendum,
    the last thing you want to do is to have yet another part of
    the global economy not doing well, and Chinese is a major part
    of the global economy.
        Senator Warren. Thank you. That is very helpful. You know,
    I hear you saying that a sharp slowdown in the Chinese economy
    would have these massive ripple effects around the global
    economy. And I understand you to be saying that in the United
    States the big financial companies would be the place where we
    would be most exposed. That is exactly in anticipation of these
    kinds of risks that Dodd-Frank requires big banks to build in
    more safety ahead of time, with capital requirements and
    leverage ratios. And that is why it is critical that financial
    regulators have the tools they need to shore up the safety of
    the U.S. banking sector.
        Every time Congress tries to weaken Dodd-Frank regulations,
    it puts our country at risk.
        Thank you, Mr. Chairman.
        Chairman Shelby. Thank you, Senator Warren.
        Just a few observations from the hearing but from our
    experience, too. We know that China--or at least my
    observation--I have been there. I have not lived there, but I
    have been there since 1981 a number of times, and I have seen a
    lot of changes. But China signs these agreements, these trade
    agreements, and then they make their own rules or ignore what
    we are doing. They are obviously ``eating our lunch'' in trade.
    Look at the current account, you know, what we are doing there.
    There has got to be a day of reckoning there.
        We all know we have to trade. My gosh, we have got to
    trade. We cannot build walls around this. But is the problem
    with China that China is going to sign an agreement and do what
    they want to? Because the imbalance of trade with China, not
    just steel--but steel is important, you know, to us for defense
    and everything that goes with this. But they seem to target an
    industry, a big industry, and people disappear. You know,
    companies disappear, jobs disappear. And this has now
    manifested itself into the current Presidential race--do not
    kid yourselves--in the current races around here. Are we
    trading? Are we smart? Are we stupid or whatever? Dr. Wilson?
        Mr. Wilson. Yeah, I would say this: During the 4 years I
    was there, the most significant change I witnessed in China is
    the fact that if you talk to the U.S. Chamber of Commerce, the
    European Chamber of Commerce, they will tell you this
    unambiguously: that doing business in China has become much
    more difficult in terms of regulation, in terms of entry,
    getting into the market.
        Obviously, you know I am with the Heritage Foundation, so I
    am a free trade guy. But, still, we ran a trade deficit--it is
    mind-boggling. We ran a trade deficit last year with China of
    $365 billion. That accounts for about 80 percent of our annual
    trade deficit.
        Chairman Shelby. Isn't that unsustainable economically
    speaking? I mean, it will go on for a while.
        Mr. Wilson. It can go on for a while. The great thing about
    the U.S. economy is this: that it is very insular. If you look
    at exports and imports as a share of GDP, it is only about 25
    percent. Other countries like South Korea, Taiwan, it is 70, 80
    percent. And so the fact is this: The global economy is growing
    at one-half the rate it was a decade ago. These have been tough
    times. Brazil, Lula said in 2009, when they were booming and we
    were in trouble, that the financial crisis was caused by blond-
    haired, blue-eyed bankers. As a former banker, I took some
    resentment for that, and I said that, you know, given their
    connectivity with the Chinese economy, this is a major reason
    why China, Indonesia, South Africa, Russia--I mean, oil prices
    as recently as 2014 were above $100 a barrel. Now we are at
    $40. Who would have expected oil to be a $40 a barrel? This is
    largely the result of the slowdown. We are already experiencing
    this. The Chinese economy has already slowed down. As recently
    as 4 years ago, it was growing at 10, 10.5 percent, now maybe 5
    percent. That is an enormous deceleration for an economy
    producing one-third of global economic growth since 2008.
        But, yeah, I will just finish by saying that it is very
    disappointing. I talk to businessmen in Beijing, and doing
    business there for the corporate blue chips has become
    increasingly difficult.
        Chairman Shelby. But we should have no illusions that China
    is trading with the United Kingdom or with Germany or anybody
    else?
        Mr. Wilson. Correct.
        Chairman Shelby. It is a different world, is it not?
        Mr. Wilson. It is.
        Mr. Shea. Could I--Mr. Chairman, you are exactly right, Mr.
    Chairman, your comments, and you asked the question, ``Are we
    stupid?'' Let me add another layer to your question. We are the
    China Economic and Security Review Commission. The United
    States has brought China into the world, has helped build up
    its economy by providing a market, by investing, and by
    transferring, whether we like it or not, technology to China.
        Chairman Shelby. Big time.
        Mr. Shea. While we are doing it, the Chinese are using the
    money to buildup their military, 10 percent a year over the
    past 15 years, and they are----
        Chairman Shelby. Oh, yes, and will continue.
        Mr. Shea. Yeah, and their military strategy is designed in
    part directed at the United States, to keep us out of the
    Western Pacific. So they are building weapons systems that
    would attack U.S. military assets.
        So are we stupid?
        Chairman Shelby. That is the question.
        [Laughter.]
        Senator Brown. This is kind of amusing. I was in the House
    when permanent normal trade relations (PNTR) passed, and I
    helped to lead the opposition to it, and I heard--normally,
    CEOs of big companies come to Congress and go to leadership
    offices in the House and the Senate. They actually come see
    people like Senator Shelby and me, but in the House they go to
    the leadership. But the CEOs of the biggest companies were even
    going to the fifth floor of Cannon to lobby on PNTR. And they
    would always talk about they could not wait to get access to 1
    billion Chinese consumers. Well, they really were looking to
    get access to 1 billion Chinese workers. And when I hear Dr.
    Wilson in his first
    testimony--again, nice work, but when you said how these
    corporate blue chip companies, it is so hard for them in China,
    I mean, it was not my idea that they go to China. It was not my
    idea that Apple does all the innovation in this country and
    then goes and outsources its jobs. It was not my idea that
    these companies begin almost a new phase in economic history
    where they shut down production in Cleveland and Toledo and go
    to Wuhan and Shihan, get a tax break to do it, and then sell
    the products back in the United States. That was not invented--
    that was what the U.S. Chamber of Commerce and major companies
    did. And when I hear them say, ``Oh, it is so hard to do
    business in China,'' then come back. But the dollars that you
    are--I mean, I do not really know who funds the Heritage
    Foundation. I suppose it is the Koch Brothers that fund most of
    everything else in this town. But I do know that you talk about
    the Chamber of Commerce and how their members have made so much
    money at the expense of my once-middle-class workers in
    Mansfield, Ohio, where I grew up, and Akron and Youngstown and
    Steubenville and Worcester, Mass., and then I hear complaints
    about how hard it is for these businesses to outsource jobs
    from China, and you talk about the Presidential election, this
    suit I wear, made by union workers 6 miles from my house in
    Cleveland, Ohio. Yet we have Presidential candidates that
    complain about trade policy and then they outsource jobs
    because they cannot find a company in the United States to make
    their furniture. Go to Archbold, Ohio. They can find a company
    that makes furniture. They can find suits here.
        So I just--when I see the business model of this country in
    the last 25 years, in many ways accelerated by PNTR, bad
    decisions in this body, and they move overseas after shutting
    production here, sell those products because the labor is
    cheap, the environmental rules are weak, the currency is in
    their favor, and now they complain about it, I guess I would
    just say, ``Come home, then.'' Enough said.
        Mr. Gibson. You know, China joined the WTO. The WTO did not
    join China. Right? We have got to hold them to the rules. We
    have got to use our trade laws when they violate the rules and
    be able to have remedies against them.
        Chairman Shelby. Well, I thank all of you. I think this has
    been an interesting hearing. We have to face reality.
        The hearing is adjourned.
        [Whereupon, at 11:25 a.m., the hearing was adjourned.]
        [Prepared statements and responses to written questions
    supplied for the record follow:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                  PREPARED STATEMENT OF DESMOND LACHMAN, Ph.D.
                Resident Fellow, American Enterprise Institute *
    ---------------------------------------------------------------------------
         * The American Enterprise Institute for Public Policy Research
    (AEI) is a nonpartisan, nonprofit, 501(c)(3) educational organization
    and does not take institutional positions on any issues. The views
    expressed in this testimony are those of the author.
    ---------------------------------------------------------------------------
                                 July 14, 2016
        Thank you Chairman Shelby, Ranking Member Brown, and Members of the
    Committee for affording me the honor of testifying before you today. My
    name is Desmond Lachman and I am a Resident Fellow at the American
    Enterprise Institute. I am here in my personal capacity and I am not
    here to represent the AEI's view on the subject under discussion.
    Introduction
        The Chinese economy, which is now the world's second largest
    economy and the world's largest trading nation, has become highly
    imbalanced as a result of an excessive reliance on credit creation and
    on investment-led growth. As a result, China's economic growth model is
    now showing every sign of having run its course. This has prompted the
    Chinese government to recognize the need for more balanced economic
    growth and has led it to significantly mark down China's long-term
    economic growth forecast.
        It would be a mistake for U.S. policymakers to minimize the large
    adverse impact that a further slowing in the Chinese economy could have
    on the U.S. economy. Since a change in the economic fortunes in China
    could have a strongly adverse impact on the world economic outlook and
    on global financial markets. This would seem to be especially the case
    at a time that the world economy is drowning in debt and at a time that
    it is confronted with an unusual confluence of material downside risks.
    These latter risks include those emanating from last month's Brexit
    referendum, from the Brazilian economic and political crisis, and from
    the serious weaknesses now being revealed in the Italian banking
    sector.
    China's growth model has become increasingly unbalanced
        In assessing China's potential to impact the U.S. economic
    recovery, it is well to recall how important China has become to the
    global economy. Through two decades of very rapid, albeit unbalanced,
    economic growth, China's share in the world economy has increased from
    2 percent in 1995 to 15 percent in 2015. This has made China the
    world's second largest economy ahead of Germany and Japan. In recent
    years, China, together with the other large emerging market economies,
    has been the principal engine for world economic growth. It was also a
    major factor in the super-international commodity price boom between
    2008 and 2013, which drove strong economic growth in the world's major
    commodity exporting economies.
    Figure 1: China's Role in the Global Economy
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        A primary concern about the Chinese economy is that it has relied
    excessively on an unbalanced and unsustainable economic growth model to
    drive its rapid economic growth. The unbalanced nature of the Chinese
    economy is most apparent from the fact that Chinese investment accounts
    for around 45 percent of China's GDP. It is also apparent from the fact
    that China has relied excessively on credit creation from its banking
    and shadow banking systems to drive economic growth and investment.
    Indeed, since 2009 Chinese credit to the nonfinancial private sector
    has increased by around 90 percent of China's GDP. Such a rate of
    credit expansion has been very much more rapid than that which preceded
    Japan's lost decade in the 1990s and that which preceded the U.S.
    housing bust in 2007.

    Figure 2: Private Debt Bubbles
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Source: BIS, IMF

        The excessive degree of Chinese investment and credit creation has
    given rise to a tremendous misallocation of resources. Many sectors of
    Chinese industry, including most notably the steel and construction
    sectors, are now characterized by massive excess capacity. In addition,
    excessive credit creation has spawned bubbles in the Chinese property
    and equity markets. Those excesses are now apparent in ghost towns and
    see-through commercial properties in many Chinese second-tier cities.
        As the excesses in China's economy have started to be unwound,
    Chinese economic growth has slowed markedly from its former double
    digit rates. According to Chinese official estimates, real Chinese GDP
    growth has now slowed to below 7 percent and is expected to remain
    between 6 \1/2\ and 7 percent over the next few years. However, many
    respected private sector analysts estimate that the Chinese economy may
    have already slowed to around 4 percent. Those analysts are justifiably
    fearful that China's economic growth will remain low as it transitions
    to a more balanced economic growth model.
    Delaying Reforms
        The present Chinese Administration appears to fully recognize the
    imbalanced nature of the Chinese economy and of the need to promote
    economic reforms that might make China a more consumer and service
    driven economy. To that end, the Administration has vowed to rebalance
    demand and to eliminate China's debt addiction before the country
    reaches its debt capacity limits. It has done so with the goal of
    achieving a more balanced and sustainable economic growth model.

    Figure 3: Borrowing in China is growing fast again
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        While President Xi Jingxing's administration has adopted certain
    measures toward reforming the economy, it is far from clear that it is
    fully committed to addressing China's credit addiction and to curbing
    its shadow banking system. Indeed, official data reveal that, in
    response to a slowing Chinese economy, the People's Bank of China has
    permitted yet another burst of credit as reflected in a more than 40
    percent increase in such credit for the first quarter of 2016. More
    recently, however, Chinese credit growth appears to be being reigned in
    again.
    Precedents from other credit bubbles
        The extraordinary increase in Chinese private nonfinancial sector
    credit over the past 8 years has been at a pace that exceeds those that
    have preceded other major economic and financial crises. These crises
    include Japan's lost decade in the 1990s, the Mexican peso crisis in
    1994, the Thai financial crisis in 1997, and the U.S. housing bust in
    2007. Those earlier crises would all suggest that the current Chinese
    credit bubble will not end well and that the world should brace itself
    for a prolonged period of relatively slow Chinese economic growth.

    Figure 4: Comparable Credit Bubbles
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        The fact that China's banking system is dominated by four state-
    owned banks makes it unlikely that China will experience an abrupt
    credit event like that which occurred in Asia during the late 1990s or
    in the United States in 2008. Rather, what is more likely is that the
    Chinese banking system will become increasingly clogged with
    nonperforming loans and with loans to zombie Chinese public and private
    sector companies along the lines that has occurred in Japan over the
    past two decades. This is very likely to keep China on a very low
    growth path for an extended period of time.
    China's capital flight problem
        Beyond the prospect of a slowing domestic economy, China's present
    capital outflow problem could pose a further risk to the global
    economy. During 2015, private capital outflows from China amounted to
    almost U.S.$700 billion in the wake of China's decision to move toward
    a more flexible exchange rate in August 2015 and of the correction of
    China's equity and property market bubbles. While China still has more
    than U.S.$3 trillion in international reserves, it is clear that China
    cannot sustain its recent pace of capital outflows for too long a
    period.

    Figure 5: Chinese Capital Flows
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Over the past few months, capital outflows from China have
    moderated as capital controls have been tightened and as the Chinese
    currency has stabilized. However, there is a considerable risk that
    China may feel obliged to again weaken its currency to stimulate export
    growth particularly in the context of a rising U.S. dollar in the wake
    of the Brexit vote. The experience of August 2015 would suggest that
    any significant move to a more depreciated renminbi against the U.S.
    dollar could again renew capital outflows.
    Implications for the United States economy
        It would be a mistake for U.S. policymakers to minimize the large
    adverse impact that a setback in the Chinese economy could have on the
    U.S. economy. Since a change in the economic fortunes in China could
    have a strong impact on the world economic outlook and on global
    financial markets. This would seem to be especially the case at a time
    that the world economy is drowning in debt and at a time that it is
    confronted with an unusual confluence of material downside risks
        In assessing the financial and economic risks from China, it is
    important to distinguish between the direct and indirect impacts that a
    slowing in the Chinese economy might have on the U.S. economic outlook.
    In that respect, it would seem that a further Chinese economic slowing
    should not have a material direct effect on the U.S. economy. After
    all, China accounts for only around 7 percent of total U.S. exports or
    less than 1 percent of U.S. GDP. Similarly only 2 percent of U.S.
    enterprises' net income is derived from China while U.S. bank exposure
    to China only amounts to around 1 percent of the U.S. banking system's
    balance sheet.
        By contrast, the U.S. economy could be indirectly affected in a
    major way by a further Chinese economic slowing through the effect that
    such a slowing might have on the rest of the world economy and on
    global financial markets. This might occur through three distinct
    channels:

      a.  First, a slowing in the Chinese economy would have a significant
            impact on the exports of China's Asian trading partners and of
            countries like Germany, which are very much more dependent than
            is the United States on the Chinese economy for their exports.
            As such, it could materially affect the global economic outlook
            confronting the United States.

      b.  Second, China might be forced to make use of its exchange rate to
            bolster its flagging economy especially if it continues to
            suffer from capital outflows. This could result in tensions in
            global currency markets where all too many countries are
            seeking to cheapen their currencies.

      c.  Third, a slowing Chinese economy must be expected to keep
            international commodity prices low for a protracted period of
            time. This has the potential to deepen the political and
            economic crises already being experienced in major commodity
            exporting emerging market countries like Brazil, Russia, and
            South Africa.

        Two further considerations would argue that there should be no room
    for complacency in U.S. policymaking circles about the Chinese economic
    outlook. The first is that the three channels by which China could
    affect the global economy are all too likely to play out
    simultaneously. That would only amplify their negative impact on the
    global economy. The second is that a further Chinese economic slowdown
    could trigger other major fault lines in the global economy in
    countries like Brazil, Italy, Japan, and Russia. That too would argue
    against being overly complacent about potential Chinese economic
    developments at this delicate juncture in the global economic cycle.
                                     ______

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                 PREPARED STATEMENT OF WILLIAM T. WILSON, Ph.D.
                Senior Research Fellow, The Heritage Foundation
                                 July 14, 2016
        My name is William Wilson. I am a Senior Research Fellow at The
    Heritage Foundation. The views I express in this testimony are my own
    and should not be construed as representing any official position of
    The Heritage Foundation.
    Overview
        Despite its size, direct global exposure to the Chinese financial
    system is currently still small. A regulatory wall around the Chinese
    financial system is largely responsible for this.
        A financial crisis in China is likely to lead to a heighten level
    of capital flight. The Chinese authorities and central bank would be
    forced to offset downward pressure on the yuan-dollar exchange rate buy
    selling U.S. denominated assets (i.e., primarily U.S. Treasuries).
    This, however, is unlikely to result in a significant fall in U.S. bond
    prices (i.e., a rise in U.S. interest rates) given the dollar's solid
    safe-haven status in times of global financial crises.
        Most of the fallout will be within Asia, where trading and lending
    have the strongest links and where credit has been growing the fastest
    globally since the 2008-2009 financial crisis.
    The Current State of the Chinese Economy--A Brief Overview
        There exists great skepticism about the accuracy of many Chinese
    macroeconomic indicators. There are significant reasons for this
    perception. First of all, any government exercising such a significant
    role in managing the direction of an economy is highly likely
    manipulating official statistics. In a nation of almost 1.4 billion
    people, quarterly gross domestic product (GDP) figures are often
    released just 14 days after the end of the quarter with no subsequent
    revisions. (In the United States, GDP figures undergo two revisions,
    sometimes significant, spanning out 60 days after the first release.)
        The headline figures often conveniently match Beijing's target
    figure. To admit the economy was growing at a 4 percent pace could
    cause a loss in confidence in the relatively early 10-year tenure of Xi
    Jinping. There are plenty of inconsistencies. While GDP was reported to
    grow at a 6.8 percent in 2015, electricity consumption rose by only 0.5
    percent. These two figures are simply not consistent.
        More ominous has been the level of fixed-asset investment (i.e.,
    residential and commercial construction, physical infrastructure,
    etc.). While it has fallen very modestly as a share of GDP recently,
    since the global financial crisis, it has run at approximately 45
    percent of GDP. Historically speaking, this level is unprecedented
    among the emerging market economies, even those in East Asia during
    their rapid growth periods.
        This elevated level of fixed investment has long passed its
    expiration date. Many industries such as steel, cement, rare earth
    minerals, energy refining and housing are operating at three-quarters
    capacity. This is precisely why wholesale prices have fallen for three
    consecutive years.
        A large drop in fixed-asset investment (as a share of GDP) will be
    a necessity. First, the return on these investments has been rapidly
    declining. The amount of capital needed to generate an extra dollar of
    income has more than doubled over the past decade. Even bringing this
    figure down to 30 percent of GDP is highly likely to produce
    significantly slower economic growth from current levels.
        Reflecting the drop in overall efficiency, the contribution of
    total productivity to GDP has been falling in China. From 1991-2000 it
    averaged 5.9 percent then declined to an annual average of 3.6 percent
    during the past 5 years (2011-2015). To reach a GDP growth target of
    5.5 percent to 6.5 percent per year, multifactor productivity growth
    will need to contribute to 40 percent to 50 percent of GDP growth
    moving forward.
    China's Debt
        China's total debt (household, corporate, government) is now much
    higher than in other developing economies and comparable to levels in
    the United States and the eurozone. While the size is a concern, what
    is more troubling is the speed at which debt has accumulated. It was
    approximately 150 percent of GDP in 2007 (a year before the crisis),
    and is now approximately 250 percent to 300 percent of GDP.
        The economy's debt load has more than tripled over the past 7
    years. New borrowing increased by Rmb 6.2 trillion in the first quarter
    of 2016, the largest 3-month increase on record.
        Roughly two-fifths of new debt is swallowed by interest on existing
    loans. Less credit is going to good firms for productive uses.
    Rising Defaults on the Way
        It is impossible for China to deploy all the capital productively
    over a short period of time.
        It now takes nearly four yuan of new borrowing to generate one yuan
    of additional GDP, up from just over one yuan of credit before the
    financial crisis.
        Rising debt levels cause financial distress on borrowers which lead
    to slower growth before defaults even begin increasing.
        China could experience a balance-sheet recession similar to
    Japan's. When corporate debt reaches a critical level, conventional
    monetary policy losses its effectiveness because companies focus on
    paying down debt instead of borrowing at lower interest rates.
        Official data has nonperforming loans at just 1.7 percent of total
    loans. This figure grossly underestimates the current stock of ``bad''
    loans.
        One of Beijing's new strategies to handle this problem is a debt-
    equity swap, where banks could write off problem company loans in
    return for taking equity stakes in them.
        Seeking to become less reliant on bank borrowing, Chinese
    corporations have aggressively tapped the bond market. At $900 billion,
    it is one of the largest in the world.
        Approximately 85 percent of China's bond issuers have AA ratings or
    above by domestic rating agencies, compared to Moody which rates only 3
    percent of global issuers so highly.
    The Shadow Banking System
        Five years ago, the Chinese shadow banking system was primarily
    driven by companies unable to secure traditional bank loans. Today, the
    driver is from ordinary people looking for higher rates of returns.
        China's shadow banking system is estimated to be at least two-
    thirds of GDP. As long as banks do not guarantee the principal of these
    products, they do not have to report them on their balance sheets. In
    essence, they are a hidden balance sheet.
        One big difference is that the government guarantees bank deposits
    while shadow lenders are supposed to stand on their own.
        China's shadow banking system has become large, but until now, it
    has avoided creating products similar to the mortgage-backed securities
    like in the United States before the financial crisis. Banks with the
    largest shadow loans are mid-sized institutions. Wealth Management
    Products (WMPs) account for about 15 percent of deposits at the largest
    banks but over 40 percent at mid-tier banks.
    Liquidity Issues
        Banks are increasingly relying on short-term funding from the sale
    of high-yielding wealth management products instead of stable deposits.
    This funding can quickly evaporate when defaults rise. It is probably
    only a matter of time until banks are unable to fund all their assets
    safely.
        Banks are becoming more reliant on WMPs, where they pay higher
    returns in lieu of short-term deposits and invest these in long-term
    assets. This causes a mismatch in duration. China traditionally
    restricted bank loans to less than 75 percent of their deposit base,
    but that figure is now approaching 100 percent.
        The average maturity of WMPs is only 113 days, but bank loans have
    much longer maturities, meaning that banks are forced to constantly
    sell new WMPs for funding.
    Global and U.S. Financial Exposure
        Since the 2008-2009 global recession, China has accounted for
    roughly one-third of global economic growth, by far the highest in the
    world. With a GDP of roughly $11 trillion (current prices), the second
    largest in the world after the United States, any economic slowdown in
    this Asian juggernaut is bound to have enormous global consequences.
        Since 2010, the rate of economic growth in China has decelerated
    from a 9.3 percent pace in 2011 to 6.8 percent in 2015 (and the
    accuracy of the latest figure is in serious question). The question is
    what impact a further slowdown in China would have on the U.S. economy.
        There are three primary channels in which a significant slowdown in
    China could impact the U.S. economy. The first is through trade. In
    2015, China was America's third largest export market, after Canada and
    Mexico, respectively. This was valued at $116.2 billion, a 50 percent
    increase since 2008. Exports to China accounted for 7.7 percent of
    total U.S. exports in 2015, not an inconsequential figure but not
    devastating to U.S. export revenue in the event of a further Chinese
    stall in growth. (Chinese exports to the United States were $481
    billion in 2015.)\1\
    ---------------------------------------------------------------------------
        \1\ U.S. Census Bureau, ``Top Trading Partners--December 2015),''
    https://www.census.gov/foreign-trade/statistics/highlights/top/
    top1512yr.html (accessed July 12, 2016).
    ---------------------------------------------------------------------------
        The second channel is financial. The Chinese are now the largest
    holder of U.S. debt (after Japan), standing at $1.2 trillion in April
    2016. This currently represents 20 percent of total foreign
    holdings.\2\
    ---------------------------------------------------------------------------
        \2\ U.S. Treasury, ``Major Foreign Holders of Treasury Securities
    (in billions of dollars),'' June 15, 2016, http://ticdata.treasury.gov/
    Publish/mfh.txt (accessed July 12, 2016).
    ---------------------------------------------------------------------------
        In the event of a further slowdown in the Chinese economy, the
    government may want to sell some of these securities for economic
    stimulus. This could lead to a fall in U.S. bond prices (i.e., a rise
    in domestic interest rates), depressing domestic investment. This
    impact has been discussed extensively and largely exaggerated for two
    reasons. First, the Chinese are unlikely to liquidate a large portion
    of their U.S. Treasury holdings because it might lead to a capital loss
    on their existing holding. Second, U.S. Treasuries are the most liquid
    and coveted securities in the world. In the event of an economic
    crisis, investors would flee toward Treasuries. The recent economic
    crisis illustrates this.
        The third channel is largely a positive one. The slowdown in the
    Chinese economy has significantly depressed global commodity prices.
    Despite the shale oil revolution, the U.S imported 9.4 million barrels
    of petroleum per day in 2015. While the United States exported 4.8
    million barrels per day in 2015, the net impact for the U.S. economy
    was positive.\3\
    ---------------------------------------------------------------------------
        \3\ U.S. Energy Information Administration, ``Frequently Asked
    Questions,'' April 1, 2016,
    http://www.eia.gov/tools/faqs/faq.cfm?id=727&t=6 (accessed July 12,
    2016).
    ---------------------------------------------------------------------------
        So what is the likely net impact? According to the Organization for
    Economic Co-operation and Development (OECD), a 2 percent decline in
    Chinese domestic demand growth will cause a decrease in U.S. GDP growth
    rate by approximately 0.3 percent.\4\
    ---------------------------------------------------------------------------
        \4\ Elvin Mirzayev, ``Impact of the Chinese Economy on the U.S.
    Economy,'' Investopedia, July 29, 2015, http://www.investopedia.com/
    articles/investing/072915/impact-chinese-economy-us-economy.asp
    (accessed July 12, 2016).
    ---------------------------------------------------------------------------
        Bottom line? With an economy cruising along at a lackluster 2
    percent rate of growth, this drop is not insignificant but also not
    traumatic.
        In terms of the Chinese economy, if the past 7 years have taught us
    anything, it is that financial crises typically result in a period of
    protracted slow growth. It already appears that China may be entering
    the early stages of this correction. How the Chinese Communist Party
    reacts to it will change the future of global
    geopolitics.

                            * * * * * * * * * * * * * * * * * * *

        The Heritage Foundation is a public policy, research, and
    educational organization recognized as exempt under section 501(c)(3)
    of the Internal Revenue Code. It is privately supported and receives no
    funds from any government at any level, nor does it perform any
    government or other contract work.
        The Heritage Foundation is the most broadly supported think tank in
    the United States. During 2014, it had hundreds of thousands of
    individual, foundation, and corporate supporters representing every
    State in the United States. Its 2014 income came from the following
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        Individuals 75 percent
        Foundations 12 percent
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        The top five corporate givers provided The Heritage Foundation with
    2 percent of its 2014 income. The Heritage Foundation's books are
    audited annually by the national accounting firm of RSM US, LLP.
        Members of The Heritage Foundation staff testify as individuals
    discussing their own independent research. The views expressed are
    their own and do not reflect an institutional position for The Heritage
    Foundation or its board of trustees.

     RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY FROM DENNIS
                               C. SHEA
    ---------------------------------------------------------------------------

         Please note the responses here represent my own views and not
    necessarily those of the Commission itself or other members of the
    Commission.
    ---------------------------------------------------------------------------
    Q.1.a. In your oral testimony, you stated that food security is
    a matter for which the United States needs to pay close
    attention. This is an issue that attracts increased attention
    within Congress with each passing Chinese agricultural
    acquisition.
        Do you find that China's attempts to integrate its
    strategic sectors vertically and horizontally, by coordinating
    the activities of its state-owned enterprises while deploying
    state resources to target key global industries and non-Chinese
    companies, to significantly influence China's foreign
    investment decisions in United States agriculture and to
    negatively affect its food security concerns?

    A.1.a. At present, there is no evidence of an excessive Chinese
    presence in the U.S. food supply chain. However, because
    Chinese state-owned enterprises (SOEs) are encouraged to invest
    abroad in what the Chinese government considers ``strategic''
    industries, continued Chinese investment in the U.S.
    agriculture sector should be closely monitored. Several recent
    investments illustrate how the Chinese government utilizes
    foreign investment to develop the country's domestic
    agriculture sector. In September 2013, a subsidiary of the
    Chinese meat processing company Shuanghui Group  acquired U.S.
    pork producer Smithfield Foods Inc. for $4.7 billion.\1\ Then,
    in August 2016, the state-owned China National Chemical
    Corporation (ChemChina) finalized a $43 billion bid to buy
    Syngenta AG, one of the world's largest producers of crop
    protection products, including pesticides, fungicides, and
    genetically modified seed.\2\
    ---------------------------------------------------------------------------
         Shuanghui Group is privately owned, but has received substantial
    support from the Chinese government. In a September 2014 interview with
    the Public Broadcasting Service (PBS), Shuanghui's president, Zhang
    Taixi, explained that the Chinese government had been ``very
    supportive'' of the Smithfield acquisition, offering preferential
    policies and financing from state banks to support the deal. PBS
    Newshour, ``Who's Behind the Chinese Takeover of World's Biggest Pork
    Producer?'' September 12, 2014. http://www.pbs.org/newshour/bb/whos-
    behind-chinese-takeover-worlds-biggest-pork-producer/.
        \1\ Smithfield Foods, ``Shuanghui International and Smithfield
    Foods Complete Strategic Combination, Creating a Leading Global Pork
    Enterprise,'' September 26, 2013. http://www.smithfieldfoods.com/
    newsroom/press-releases-and-news/shuanghui-international-and-
    smithfield-foods-complete-strategic-combination-creating-a-leading-
    global-pork-enterprise.
        \2\ China National Chemical Corporation, ``ChemChina and Syngenta
    Receive Clearance from the Committee on Foreign Investment in the
    United States (CFIUS),'' August 22, 2016. http://www.chemchina.com/en/
    press/press/A604001web_1.htm.

    Q.1.b. Should the various current U.S. review processes,
    including that of the Committee on Foreign Investment in the
    United States, take into account the accumulative percentage of
    market control by all Chinese state-owned enterprises currently
    operating within the U.S. agriculture sector, not just the
    immediately acquiring entity, when reviewing transactions
    ---------------------------------------------------------------------------
    involving Chinese state-owned enterprises?

    A.1.b. Yes, the U.S. Government should take into consideration
    the accumulative percentage of market control by Chinese SOEs.
    The Chinese Communist Party uses SOEs to pursue social,
    industrial, and foreign policy objectives. Therefore, SOE
    activities should be scrutinized to determine the reasons
    behind these investments.

    Q.1.c. Can an over-reliance on China for U.S. domestic food
    supply qualify as a valid threat to U.S. food security or U.S.
    national security, and what is the difference between the two?

    A.1.c. According to the United Nations Committee on World Food
    Security, food security is the condition in which all people
    have access to sufficient, safe, and nutritious food.\3\
    Meanwhile, the Heritage Foundation's 2015 Index of U.S.
    Military Strength defined national security as anything that
    protects national interests, which encompasses economic,
    military, political, and other forms of power projection.\4\ In
    general, excessive reliance on any one country for food
    products should be avoided. Current evidence does not suggest
    the United States is over-reliant on Chinese agriculture
    products, although some processed foods are sourced there.
    According to data from the office of the U.S. Trade
    Representative, top food imports from China in 2015 included
    processed fruit and vegetables ($1 billion), fruit and
    vegetable juices ($321 million), snack foods ($208 million),
    fresh vegetables ($178 million), and spices ($159 million).\5\
    Data from the U.S. Department of Agriculture show that in 2014
    (the most recent available), China was the United States' third
    largest source of imported food, with $5.8 billion worth of
    food products imported that year.\6\ Canada ($22 billion) and
    Mexico ($19.2 billion) are the largest sources of U.S. food
    imports.\7\
    ---------------------------------------------------------------------------
        \3\ United Nations Committee on World Food Security. http://
    www.fao.org/cfs/cfs-home/about/en/.
        \4\ Kim R. Holmes, ``What is National Security?'' in 2015 Index of
    U.S. Military Strength, Heritage Foundation. http://index.heritage.org/
    military/2015/important-essays-analysis/national-security/.
        \5\ Office of the United States Trade Representative, ``The
    People's Republic of China.''
    https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-
    republic-china.
        \6\ U.S. Department of Agriculture, ``Source Countries of U.S. Food
    Imports,'' March 30, 2015. http://www.ers.usda.gov/data-products/us-
    food-imports.aspx.
        \7\ U.S. Department of Agriculture, ``Source Countries of U.S. Food
    Imports,'' March 30, 2015. http://www.ers.usda.gov/data-products/us-
    food-imports.aspx.
    ---------------------------------------------------------------------------
                                    ------

    RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY FROM DENNIS C.
                                  SHEA

    Q.1.a. You stated in your testimony that the Chinese government
    ``is introducing policies that aim to replace established
    market leaders with [Chinese] firms.'' As you know, there is
    significant evidence that the Chinese government is stealing
    American intellectual property via cyber espionage and
    disseminating stolen technology to Chinese businesses.\1\,\2\
    ---------------------------------------------------------------------------
        \1\ DOJ Indictment.
        \2\ USS 337 Complaint.
    ---------------------------------------------------------------------------
        Do you agree that the theft of American intellectual
    property by Chinese agents is a serious concern?

    A.1.a. The Commission has been examining the cyber espionage
    threat China poses to the United States for many years. In
    2015, for example, the Commission held a hearing on
    ``Commercial Cyber Espionage and Barriers to Digital Trade in
    China.'' In the
    corresponding chapter of the Commission's 2015 Annual Report to
    Congress, the Commission stated that ``China causes increasing
    harm to the U.S. economy and security through two deliberate
    policies targeting the United States: coordinated, government-
    backed theft of information from a wide variety of U.S.-based
    commercial enterprises and widespread restrictions on content,
    standards, and commercial opportunities for U.S.
    businesses.''\3\ Ongoing developments in Chinese cyber
    espionage are also assessed in the Commission's forthcoming
    2016 Annual Report to Congress. The Commission expects that the
    theft of American intellectual property by Chinese government-
    sponsored and supported agents will continue and will require
    vigilant monitoring.
    ---------------------------------------------------------------------------
        \3\ U.S.-China Economic and Security Review Commission, Chapter 1,
    Section 4, ``Commercial Cyber Espionage and Barriers to Digital Trade
    in China,'' in 2015 Annual Report to Congress, November 2015, 192.

    Q.1.b. Do you think that the Administration's previous actions
    (e.g., filing criminal charges against PLA operatives and
    engaging in formal negotiations to discourage hacking) have
    ---------------------------------------------------------------------------
    been effective in reducing illegal cyber espionage?

    A.1.b. According to publicly available reporting, the
    effectiveness of the Administration's actions has been mixed. A
    June 2016 report released by the U.S. network security company
    FireEye indicates Chinese cyber espionage against U.S.
    companies has decreased in frequency since September 2015, when
    the United States and China signed a memorandum of
    understanding pledging that ``neither country's government will
    conduct or knowingly support cyber-enabled theft of
    intellectual property.''\4\ However, several other factors
    could account for the decline of Chinese espionage, including
    increased sophistication of Chinese hackers, a decrease in
    public reporting of cyber crimes, or shortcomings of U.S.
    detection capabilities.\5\
    ---------------------------------------------------------------------------
        \4\ FireEye iSight Intelligence, ``Red Line Drawn: China
    Recalculates Its Use of Cyber Espionage,'' June 2016, https://
    www.fireeye.com/blog/threat-research/2016/06/red-line-drawn-china-
    espionage.html; White House, Fact Sheet: President Xi Jinping's State
    Visit to the United States, September 25, 2015. https://
    www.whitehouse.gov/the-press-office/2015/09/25/fact-sheet-president-xi-
    jinpings-state-visit-united-states.
        \5\ U.S.-China Economic and Security Review Commission, private
    discussion with cyber security experts, June 9, 2016; U.S.-China
    Economic and Security Review Commission, Hearing on Chinese
    Intelligence Services and Espionage Operations, oral testimony of John
    Costello, June 9, 2016; U.S.-China Economic and Security Review
    Commission, Hearing on Chinese Intelligence Services and Espionage
    Operations, oral testimony of Mark Stokes, June 9, 2016; Jack Detsch,
    ``Report: China Bolsters State Hacking Powers,'' Christian Science
    Monitor, February 4, 2016. http://www.csmonitor.com/World/Passcode/
    2016/0204/Report-China-bolsters-state-hacking-powers.

       LA report by the State Department's Overseas
            Security Advisory Council noted, ``While media
            reporting has emphasized this alleged decrease in
            malicious activity, cases of Chinese espionage
            campaigns against the U.S. private sector are
            ongoing.''\6\
    ---------------------------------------------------------------------------
        \6\ Bill Gertz, ``State Department Report Says Chinese Cyber
    Attacks `Ongoing','' Washington Free Beacon, June 29, 2016. http://
    freebeacon.com/national-security/state-department-report-says-chinese-
    cyber-attacks-ongoing/.

       LIn an April 2016 interview with the Financial
            Times, Rob Knake, the former director of cyber security
            policy at the National Security Council, stated that
            while the days of widespread Chinese-sponsored
            espionage seem to be over, there's a consensus that
            ``activity is still ongoing, but [it is now]
            narrower in scope and with better tradecraft'' as
    ---------------------------------------------------------------------------
            hackers become more adept at covering their tracks.\7\

        \7\ David J. Lynch and Geoff Dyer, ``Chinese Hacking of U.S.
    Companies Declines,'' Financial Times, April 13, 2016. https://
    www.ft.com/content/d81e30de-00e4-11e6-99cb-83242733f755
    #axzz4BBcRuRz7.

       LIn June 2016 testimony before the Commission, Mark
            Stokes, the executive director of the Project 2049
            Institute, also highlighted the need to distinguish
            between China's ``A team''--or their best computer and
            information security engineers--and the ``B team,''
            which is comprised of amateur hackers.\8\ According to
            Mr. Stokes, ``the A team is still just as active'' in
            its efforts to exploit vulnerable U.S. computer
            systems.\9\
    ---------------------------------------------------------------------------
        \8\ U.S.-China Economic and Security Review Commission, Hearing on
    Chinese Intelligence Services and Espionage Operations, oral testimony
    of Mark Stokes, June 9, 2016.
        \9\ U.S.-China Economic and Security Review Commission, Hearing on
    Chinese Intelligence Services and Espionage Operations, oral testimony
    of Mark Stokes, June 9, 2016.