[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.
______
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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
sources:
Individuals 75 percent
Foundations 12 percent
Corporations 3 percent
Program revenue and other income 10 percent
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.