HK LEADERS TELL DALLAS FED CHIEF CHINA NEEDS U.S.

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 000747

SIPDIS

STATE FOR EAP/CM AND EEB/IFD/OMA, TREASURY FOR OASIA

E.O. 12958: DECL: 04/23/2034
TAGS: ECON EFIN HK CH
SUBJECT: HK LEADERS TELL DALLAS FED CHIEF CHINA NEEDS U.S.

REF: HONG KONG 720

Classified By: Consul General Joe Donovan, Reasons 1.4 b/d


1. (C) Summary: Dallas Federal Reserve President Richard
Fisher and staff met with Hong Kong government officials,
business and finance leaders and the media April 14-15 to
explain recent U.S. Federal Reserve actions and to hear local
concerns. He reassured interlocutors that the U.S. economy
will emerge from the financial crisis stronger and more
efficient and promised that the Fed would keep a close watch
for inflationary pressures. Business and government leaders
told Fisher Hong Kong is beginning to recover already and
remains China's only real window into the international
financial system. Chinese investors may be interested in
Western assets, but will move cautiously in light of their
past difficulties. The Chinese leadership is focused on
economic development, continues to believe that the U.S. is
still the most efficient economy in the world, and
understands that China cannot grow absent a U.S. recovery.
Boosting domestic consumption in China is crucial for its
continued growth, but will take years and face significant
bureaucratic obstacles. Chinese leaders were "amazed" at
President Obama's election and are willing to "give him a
chance." A recent proposal to consider using SDRs as an
international reserve currency is more of an intellectual
exercise than a policy prescription, but the Chinese are
likely to shift their reserve holdings around the edges to
better reflect trade obligations and diversify into
non-sovereign bonds. End Summary.


2. (U) Dallas Federal Reserve President Richard Fisher,
accompanied by Senior Economists Mark Wynne and Tao Wu, met
with a wide range of senior Hong Kong officials and business
leaders, including Hang Lung CEO Ronnie Chan, Mass Transit
Railway Corp. (MTR) CEO Raymond Ch'ien, Citibank Asia
President Shengman Zhang, Goldman Sachs Managing Director for
China Fred Hu, Hong Kong Stock Exchange Chairman Ronald
Arculli, members of the Hong Kong/U.S. Business Council,
Director General of the Hong Kong Chief Executive's Office
Norman Chan, Financial Secretary John Tsang, and Hong Kong
Monetary Authority Chief Executive Joseph Yam (reported
reftel). Fisher spoke at a well-attended luncheon hosted by
the Asia Society and took advantage of Hong Kong's
proliferation of international media outlets to give
interviews to CNN International, Bloomberg Asia, MSNBC, and
the Hong Kong Economic Journal, as well as conduct an
impromptu press conference following his Asia Society remarks.


Nurturing Green Shoots, Stopping Deflation
======================= ==================


3. (SBU) In each meeting, Fisher reinforced the message that
the U.S. Federal Reserve Board (FRB) has taken extraordinary
measures to provide liquidity to the market and with U.S.
Treasury has successfully stabilized the financial markets
for now. "Green shoots" of recovery are beginning to appear,
but much work remains to be done to purge bad assets from
bank balance sheets and improve regulatory oversight before
the U.S. economy can recover. Although unemployment is
likely to exceed 10 percent by 2010, Fisher reassured
interlocutors that the U.S. economy will come out of the
current crisis stronger and more efficient. He acknowledged
concerns about inflation resulting from the FRB's
quantitative easing policy, but promised the Fed would watch
closely for any inflationary signals and pointed to the
potential for deflation as a much greater threat in the
current environment. Fisher noted that the U.S. and Chinese
economies are closely linked and continued Chinese economic
growth is dependent on an American recovery. His public
remarks were well received and repeated several times on
international news broadcasts.


Chinese Cautious on U.S. Investments
====================================


4. (C) Hong Kong Stock Exchange Chairman Arculli agreed that
China needs U.S. markets and expertise to return to its
normal rapid pace of economic growth. Chinese companies,
both private and state-owned enterprises (SOEs) are trying to
attract overseas talent. Arculli, a respected barrister
himself, noted that the largest law-firm in China, of which

HONG KONG 00000747 002 OF 003


he is a partner, is run by Chinese lawyers educated in the
West. Many of those returning to China find it difficult to
adjust to the bureaucracy and hierarchical management system.
That bureaucracy will slow the pace of Chinese investment in
the west, according to Arculli. While the China Investment
Corp. (CIC) and other SOEs have been cautiously moving to
purchase foreign assets, previous losses and resistance from
foreign populations are giving them pause, he said.


China Needs Hong Kong, Social Safety Net
========================================


5. (C) Hong Kong's economy is in relatively good shape and
still plays an important role for China, despite official
support from the Chinese leadership for Shanghai as an
international financial center, said Financial Secretary (FS)
John Tsang. For now, Hong Kong is China's only real window
into the international financial system, he said. Rule of
law, accounting standards, and a freely convertible currency
give Hong Kong an advantage Shanghai will not be able to
overcome for many years. Tsang pointed to the announcement
that Hong Kong would be the first jurisdiction to engage in
Renminbi (RMB) trade settlement transactions. Hong Kong has
already developed a clearing system, he said, and is the
logical place to test initiatives designed to gradually
increase RMB convertibility. This will encourage additional
RMB business in Hong Kong and will complement the other
pillars of HongKong's economy: financial services, trade and
loistics, tourism, and professional services, said Tang.


6. (C) Citibank Asia President Shengman Zhang agreed that
Hong Kong's economy looks to be nar the end of its slide.
He predicted Hone Kong ould see additional bankruptcies, but
thought th local economy is starting to turn around. Japan,
Korea, Singapore and India are muc worse off, while
relatively closed economies like Bangladesh and Sri Lanka
have escaped the majority of ill effects, said Zhang.
China's large reserves and its ability to quickly increase
fiscal spending will help it to keep economic growth rates
high, but he was skeptical that the fiscal measures would
result in a net increase in employment. China needs to
create a social safety net and invest in human capital in
order to reorient its economy towards domestic consumption.
These goals will take years to meet and the results are not
immediately observable, making social spending less
attractive to ambitious bureaucrats, he said.

Chinese Leaders: Economics Paramount, U.S. Still Most
Efficient
================ ====================
=========================


7. (C) Goldman Sachs' Fred Hu recounted a recent meeting
with People's Bank of China (PBOC) Governor Zhou Xiaochuan
and CIC Chairman Lou Jiwei where Zhou and Lou suggested that
political and military issues are secondary to China's
economic agenda. The Chinese leadership understands that
their economic success is linked closely to a U.S. recovery
and they are eager not to do anything to derail the U.S.
economy. The rapid collapse of Fannie Mae and Freddie Mac,
Lehman Bros., AIG and other American financial institutions
took the Chinese leadership by surprise, said Hu, and the
U.S. response did not immediately bolster confidence.


8. (C) Chinese leaders, however, still trust the strength of
U.S. system. Hu recounted a December 18 Central Party
Committee meeting where President Hu Jintao reportedly told
those assembled, "do not underestimate the U.S. Although the
financial crisis is severe, it will not undermine the U.S.
system. The U.S. is still the most efficient economy in the
world and the U.S. dollar is still the international reserve
currency; that will not change any time soon. Although
Chinese banks are not heavily exposed to the financial
crisis, China is still far behind the U.S. in risk
management." Fred Hu pointed to these remarks as evidence
that despite some populist rhetoric in the Mainland press,
the Chinese leadership are not congratulating themselves, but
are rather very clearheaded about the challenges ahead.


SDR Proposal Just Intellectual Debate
=====================================


HONG KONG 00000747 003 OF 003



9. (C) Dallas Fed Senior Economist Tao Wu asked how
President Hu's comments should be taken in light of PBOC
Governor Zhou's recent comments advocating use of the IMF
Special Drawing Rights (SDRs) as a global reserve currency.
Hu speculated that Governor Zhou may have been floating his
own idea as a topic for intellectual discussion, or perhaps
spoke out of frustration. Zhou made a similar comment at a
conference in Malaysia in February that did not provoke much
attention. Hu spoke to Zhou both before and after the SDR
comment, but on neither occasion did Governor Zhou raise the
issue. There is no way to move away from U.S. Treasuries,
but the PBOC is likely to rethink its reserve management
strategy, said Hu. He predicted the PBOC would give greater
consideration to the composition of trade in its reserve
allocation, but may be more aggressive in terms of assets,
perhaps including purchases of highly rated corporate bonds,
including dollar denominated bonds. Although the CIC was
burned previously by investments in U.S. assets, when the
U.S. economy stabilizes it may begin looking at opportunities
in the U.S. market, said Hu.


President Obama Proof U.S. Not Just Talk
========================================


10. (C) Hu encouraged Fisher to invite the PBOC to send
staff to the Dallas Fed as a means of improving communication
between the central banks. He noted that the Strategic
Economic Dialogue has been a useful tool for improving
understanding and was optimistic that the new Strategic and
Economic Dialogue would continue to prove valuable. Chinese
leaders were very happy with Secretary Clinton's recent visit
and are positive towards the expanded dialogue. Hu
characterized the Chinese leadership as being "amazed" at
President Obama's election. Even the most vociferous critics
of the U.S. were silenced. President Obama's election is
viewed as proof of America's meritocratic system and Chinese
leaders are generally "willing to give the President a
chance," said Hu.
DONOVAN