In recent years, China’s central bank has accumulated foreign currency reserves at a very fast rate. China’s foreign currency reserves have increased from $400 billion in 2003 to around $2,000 billion in 2008—a five-fold increase in 5 years. An increase of such magnitude will present a huge problem for the Chinese economy. When the Chinese exporters, American multinational corporations, or Wall Street financial speculators exchange American dollars for Chinese Renminbi at their banks, the Chinese central bank has to issue an equivalent Chinese currency. This will increase China’s money supply, dilute the value of the Renminbi, increase inflation; and create an asset-price bubble and bad loans in the banking system.

     Since 1971, when President Nixon abandoned the Bretton Woods Agreement, which pegged the value of the dollar to gold, and the dollar became a de facto world reserve currency, the only way for central banks in the world to invest their dollar trade surplus was to buy American Treasury bonds, as world central bankers are generally very conservative people, and they do not want to take the undue risk of investing in anything other than Treasury bonds. However, in 2007, China set up a State Investment company and tried to diversify its investment. As a result, it bought a $3 billion stake in the U.S. private equity firm Blackstone. Unfortunately for China, this investment suffered a $540 million paper loss after only 24 trading days when Blackstone went public one month following the Chinese share purchase. Since then China’s share in Blackstone has had a paper loss of more than 85%. China lost more than $2.5 billion on an investment of $3 billion.

        One wonders why China would invest a huge sum of money in a speculative venture like Blackstone and pay such a hefty price for its shares. Is this business transaction in the interests of the Chinese people?

       Since President Nixon abandoned the gold standard in 1971, U.S. administrations have had no interest in a balanced budget, nor are they concerned with trade deficit. Fiscal and monetary expansions have been the order of the day. The printing of dollar not only inflated the American economy, but exported inflation to the rest of the world as well. Consequently, the American economy became a debt-ridden economy. The American government, consumers and corporations have all been burdened with high levels of debt. The federal debt is now estimated to be more than $10 trillion, and this does not include the potential liabilities of the massive Wall Street bailout last fall. The federal debt does not include future obligations such as Medicare and Social Security that have already reached over $50 trillion. With so many debts, one can readily realize that the present crisis is essentially a debt crisis.

         In addition to debt and the Federal deficit, the American trade deficit was over $700 billion both in 2007 and 2008, and external debt is now $4 trillion. External debt is public debt owed to central banks all over the world. In addition to public debt, American corporations owe a few more trillion to the rest of the world. America, supposedly the richest industrial country in the world, borrows as much as $2 billion every day from countries like China and Japan as well as from Middle East oil producers.

      As a result, the purchasing power of the dollar has declined, losing more than 80% of its value since becoming a fiat currency in 1971. In 2007, the dollar hit an all time low against the Euro. 

      Therefore it is all the more puzzling that the Chinese central bank still holds the most U.S. treasury bonds—to the tune of over $730 billion, according to the U.S. Treasury. This is in addition to another $450 billion of Fannie Mae and Freddie Mac “mortgage-backed securities”.

      To many it is illogical that hundreds of millions of hard-working Chinese have to work in miserable working conditions, receive meager wages and produce hundreds of billions of dollars of consumer goods, at a great sacrifice to the environment only to see these consumer goods sent to America in exchange for a piece of paper called a treasury bond that will never be repaid and, in the end, will become worthless.

       Obviously, China is not only losing heavily from dollar devaluation, but is subsidizing America to the tune of hundreds of billions of dollars a year. One might ask why the Chinese government does not sell its vast holding of U.S. dollars and spend it on infrastructure projects, health care, and education for the benefit of Chinese citizens at home.

 

       Unfortunately for China, the selling of the dollar will raise the value of its own currency—the Renminbi, making her exports uncompetitive in the world market. As an exporting nation, this is not acceptable for China. Thus, China is forced to buy U.S. Treasury bonds and become a creditor to the U.S. government, enabling the U.S. to finance its federal deficit, to conduct war in Iraq and to cut taxes for the wealthy. This is a rather unfair exchange, as the U.S. is paying paper dollars or paper bonds for China’s natural resources, goods and services. Consequently, America is in the enviable position of having all the dollars spent abroad, either to import consumer goods from China or for direct foreign investments into China and then having all the dollars end up deposited in China’s central bank and recycled back to Washington in exchange for U.S. treasury bonds. 

      The major problem concerning the accumulation of too much export earnings in the form of U.S. Treasury bonds is that they are not available for domestic development, and exporting nations are directly transferring their real wealth to the United States. Trade surpluses accumulated by China and other nations become part of the U.S. financial system rather than being used to build up their own economies.

 

The use of excessive foreign currency reserves to buy up American industries has been proposed by Prof. Michael Hudson. 

          Unfortunately, America blocked foreigners from buying control of its banks, oil companies, airlines, defense industry, telecom and technology companies. In this connection, we would like to point out that China couldn’t even buy a 100 year-old America company like Maytag. The takeover of Maytag by China, according to the 2008 Nobel Laureate, Prof. Paul Krugman, presents “The Chinese Challenge”. Obviously, Mr. Krugman does not believe in level playing fields, as under the WTO rules, American multinational corporations can rush into China, play the takeover game or receive national treatment for foreign direct investment, thereby dominating key sector of the Chinese economy. It looks as if the ghost of the 19^th century unequal treaty imposed on China by the Western imperial powers has reappeared.

        Incredibly, many of these companies taken over by foreigners were financed by Chinese state banks. The Chinese companies are not only purchased at a fraction of their real value, but sometimes they are financed 100% by China’s state banks. Moreover, foreign investments in China are only taxed at half the rate paid by Chinese firms.

       The lending of money to buy out national industries is the equivalent of financing foreigner to buy your own house. Very soon, this stranger, who proclaims himself your friend will kick you out while he still owes money to you, and you will become destitute, while holding a piece of paper called a mortgage, which is depreciating at a very fast rate. In China’s case, this piece paper is called a U.S. Treasury bond, which is also depreciating very fast. 

         I have always thought that we Chinese are very savvy when it comes to business, as we have had thousands of years of experience in commercial activities. It is very troubling to me that this kind of stupidity is occurring in China today. After much soul searching, I came to the conclusion this was due to two factors: one is neo-liberalism which is embraced by Chinese mainstream economists and Chinese economic elite. They view the takeover of China’s industries by multinational firms as benign, and as a means of obtaining technology from abroad. This is absurd, as even former U.S. Treasury secretary Henry Paulson admitted in his September 2008 Foreign Affairs magazine article, in which he wrote that American corporations only sent second generation technology to China. This kind of “open door policy” is akin to being robbed by friends who are thieves. This is really sad. 

        This is really tragic for China. After a hundred years of revolutionary struggle at the sacrifice of tens of millions of lives, China seems to be on the verge of becoming an economic colony of the United States, right back where she started more than a century ago. This is not acceptable to any patriotic Chinese. 

        Another way to deal with is to use the excessive foreign currency reserves is to buy out the American overseas investments, but that would also encounter opposition from American politicians, as witness the Unocal takeover battle in 2005. However, the acquisition of American subsidiaries in China may be a realistic alternative, as America is now an indebted nation and China has the right to exercise her own sovereign power to regulate business within her own borders. This surely will draw confrontation with Washington, but China should not be afraid of this once she regains her economic sovereignty. 

      While admitting the soundness of all these admirable suggestions, we would like to point out that the most important thing for Chinese people and their leaders  to realize is that China must move away from trade dependency, especially trade dependency on the United States and regain her economic sovereignty. China would then be able to concentrate her energy on developing her own domestic economy and creating her own demand.

      Trade dependence on a great power such as the United States subjects a country to economic and political pressure. A case in point is America's constant pressure on China to reevaluate her currency, to open her financial markets and to allow free capital flow. Allowing capital to flow into China forces the Chinese central bank to expand the money supply and this has resulted in high inflation for the Chinese economy. To counter inflationary pressures and cool down the stock and property markets, the Chinese central bank increased interest rate six times during 2007. The increase in rates and the American subprime mortgage credit crisis ignited panic dumping of Chinese stocks by foreign investors which sent the Chinese market into a tailspin. Millions of Chinese investors, who were new to the game of investing and had invested all their savings in the stock market, suffered enormously.

      In this connection, you might recall the disaster of the Asian Financial Crisis. The main culprit, as in the case of the recent Chinese stock market crash, was global financial liberalization. The Asian Financial Crisis was due to excessive foreign capital inflow that ended with the collapse of the real estate and stock market. It dealt a huge blow to the Asian economies. Overnight, $100 billion of foreign currency reserves disappeared from the central banks of these Asian countries. These foreign currency reserves were appropriated by Wall Street financial speculators. Related financial losses surpassed even the levels caused by World War II. The Asian Financial Crisis at first appeared as a currency crisis, but it was also a stock market crisis. In China, the stock market crisis was not a result of the currency crisis, but was similarly due to excessive speculative capital inflow, that led to the collapse of the stock market.

       The economic consequences for China were incalculable. China was not only faced with the problem of excessive capital inflow—hot money, but with high inflation, a stock market crisis, a loss of savings for many first time investors and the development of a casino economy. More importantly, with the accumulation of excessive foreign reserves, China will be on the way to hyperinflation. Hyperinflation would destroy Chinese society and the moral authority of the party in power, as in the case of the Guomindang regime exactly 60 years ago. In the end, the cost will be borne by ordinary Chinese who will experience not double digit but quintuple or sextuple digit inflation, the loss of life-time savings, high unemployment, stagnant or declining wages, social devastation, or even abysmal poverty.  

       It is obvious that China will not solve the problem of excessive foreign currency reserves by deepening its relationship with America through transaction such as the purchase of Blackstone shares. This transaction, even profitably invested, let alone suffering a huge loss, serves no useful purpose for China, as this investment remains part of the U.S. financial system, and stands only to benefit U.S. financial capital.

      It is obvious, as previously stated, that China must regain her economic sovereignty, and abandon trade dependency, especially trade dependency on the United States. While declaring that China must abandon trade dependency, we are not advocating isolationism, and we maintain China should develop trade with all the countries including the United States, on the basis of equality, mutual benefit, not on exploitation of human capital and natural resources.   

      It is equally obvious that China must abandon the WTO and its intellectual property rights regime, which is an impediment to the development of science and technology in China. Under WTO rules, U.S.-subsidized agricultural products including many GMO foods which have flooded the Chinese market. It goes without saying that China’s farmers are suffering stiff competition from subsidized and potentially toxic GMO foods, losing market share and income, and even the incentive to farm. This could have huge implications for China, as no country can produce enough food to feed the billion of Chinese. Moreover, WTO rules grossly infringe on China’s sovereignty, as many of the structural adjustment programs such as financial liberalization, privatization, and national treatment for foreign direct investment that were previously applied to Third World indebted countries are now applied to China. 

     Adding insult to injury, China is currently the country with the most foreign currency reserves in the world, and happens to be the number one creditor of the United States. Logically, it is the United States, as the indebted nation, that should be subjected to many of these structural adjustment programs. But I can assure you this is impossible as long as the IMF and the World Bank are controlled by Washington.

       For this reason, China must stop embracing the agendas of the World Bank and IMF, which are the instruments used for economic aggression by the Western imperial powers against the third world countries. Otherwise, the Chinese people will be condemned to a perpetually low standard of living and suffer from slow technological progress together with environmental degradation and resource depletion of their country. 

      The abandonment of the WTO and trade dependency, the acquisition of U.S. subsidiaries in China by the Chinese firms, and the return of unwelcome U.S. Treasury bonds to America by China will lead to a financial showdown with Washington. This is especially significant at the time of global crisis of capitalism when the United States is in economic decline and experiencing the worst financial disaster since the Great Depression.

       The global crisis of capitalism demonstrated once and for all the fallacy of the misguided “Open Door” policy and the use of exports as a driver of Chinese economic development. As a result of the global economic crisis, tens of millions of workers in China were laid off and hundreds of thousands of business enterprises went bankrupt. It is obvious that China cannot continue on this path of development, and that this is the turning point for China. It is time for China to abandon the neo-liberal economic policy and adopt the policies of self-reliance, of independent development, of protection of national industries from predatory western multinational corporations, and of emphasis on independent research and innovation. Above all, it is time for China to restore the agricultural coops, in order to achieve large scale farming. It is time for China to invest and develop her agricultural sector, especially the village industries, so as to raise the standard of living of the majority of the Chinese people. It is time to repair China’s environment. It is time for China to undertake a massive irrigation program to develop her Northwest, which will not only provide tens of millions of jobs to her citizens but achieve a potential big payoff in food production and an increase in the size of China’s agricultural territory. This project is in direct contrast to the present policy of real estate development in China which has resulted in the wasteful use of fertile farm lands and could lead to a speculative bubble. 

      Ladies and Gentlemen, today I have mentioned many potential crises confronting China. They include rapid depreciation of the dollar, hyperinflation, development of a casino economy, a looming crisis in agriculture as a result of the destruction of large scale farming together with the importation of subsidized American agricultural products which include the potential toxic GMO foods, environment degradation, domination of foreign capital in China resulting in the dismantling of China’s national industries, and the real estate bubble.