China

Ford announced this week that instead of building its new Focus – the best-selling car in the world – in a new $1.6 billion dollar Mexico-based plant, it will ship cars for North American customers from China. Ford has promised that its decision won’t reduce its workforce. Yet even if that is true, American workers will lose. Today the compact Focus uses steel from Wisconsin, axles from Oregon, seatbelts from Indiana, grills from Michigan, tire pressure sensors from Tennessee, front-side shafts from North Carolina and Ohio, and the list goes on. With the shift, these raw materials, parts and components will be sourced and put together in Asia, eliminating dozens of U.S. based suppliers, and likely costing many of their employees their jobs. While assembly was scheduled to move from Michigan to Mexico, that would have ensured ongoing American employment – as over 40 percent of the value of vehicles “made in Mexico” comes from U.S. factory floors and U.S. offices. For products imported from China – as the new Ford Focus will be starting in 2019 – this number is a negligible 4 percent. Ford made the decision first and foremost for market reasons. China’s 28 million vehicle market is the largest in the world. And while U.S. demand for smaller cars has faltered, in China it is growing at a robust 4 percent annually. Already nearly half of the million Ford Focus models sold each year go to Chinese buyers. Importing vehicles isn’t an option as the United States doesn’t have a free trade agreement with China, so cars coming from abroad face a stifling 25 percent tariff. View full text of article, originally published in Americas Quarterly.

In previewing this week’s inaugural U.S.-China Diplomatic and Security Dialogue, acting Assistant Secretary of State Susan Thornton took a question from Anne Gearan of The Washington Post about the Trump Administration’s approach to the South China Sea. Thornton’s short response neatly embodied two major deficiencies in current U.S. policy that are paving the way for a Chinese sphere of influence in Southeast Asia. (I address both in deeper detail and offer alternatives in the July/August edition of Foreign Affairs in a piece entitled, “Course Correction:  How to Stop China’s Maritime Advance.”)   First, Thornton repeated the oft-heard U.S. call for China and the other claimants in the South China Sea to cease ongoing militarization of their occupied islands. Thornton noted that, “what we think should happen is that all parties should freeze any construction or militarization of features that they have outposts on.” But here’s the problem: a U.S. preference for non-militarization is not going to change China’s behavior unless it is backed up by clear and credible consequences for what the United States is prepared to do if China continues down the current path of transforming its artificial islands into advanced military bases. As long as China faces little to no costs for its actions, what the United States thinks “should happen” will remain irrelevant.   Second, and related, Thornton concluded by noting that, “We think it’s important that tensions are lowered over these issues.” This revealing comment illustrates the endemic risk aversion in U.S. policy that has come to submerge vital U.S. interests in Asia. Consistent with over a hundred years of U.S. grand strategy, the principal goal of the United States in the South China Sea should be to prevent domination by a rival power, in this case China. Sometimes that may mean trying to lower tensions, but at other times the United States must be comfortable with a more contentious and competitive dynamic. Simply seeking to lower tensions as a policy goal in and of itself has instead created a permissive environment for Chinese assertiveness and militarization. As I wrote with Elbridge Colby in Foreign Policy back in 2014, “China is taking advantage of Washington’s risk aversion by rocking the boat, seeing what it can extract in the process, and letting the United States worry about righting it.” This is still the case today.   If the Trump Administration is serious about preventing Chinese control of the South China Sea, it will have to stop committing these two cardinal sins of U.S. policy.

Over the past two decades, subsequent Chinese governments have invested heavily in soft power, particularly in developing regions of the world. Beginning in the early 2000s, Beijing began dramatically boosting its aid outlays, promoting new cultural and educational exchanges, expanding and modernizing Chinese media outlets overseas (some, potentially, with Russia’s outlets as a model), and increasing training for foreign officials in China, among other measures. Overall, the goal of these soft power efforts seems to be similar to soft power strategies of other major powers, including the United States, France, Britain, and Japan: to bolster China’s reputation overseas, and potentially make it easier for Beijing to gain other, more tangible foreign policy goals. For instance, if China is perceived favorably in foreign nations, it may be easier for Beijing to negotiate free trade deals with other nations, launch joint military operations, boost diplomatic relations, and achieve other goals. A decade or so ago, Beijing appeared to be succeeding in its soft power strategy. It had utilized many of these soft power methods to raise its favorability around the world, and to soothe concerns in Southeast Asia, Northeast Asia, and South Asia about China’s growing diplomatic, economic, and strategic influence. But that strategy has come into conflict, in Southeast Asia, with China’s hard power aims. I participated in an online forum on China’s soft power organized by the National Endowment for Democracy. You can see my part of it, and all the responses, here.

Since April, cases of Ebola virus disease (EVD) have been reported in the Democratic Republic of Congo. As of June 6, there were eight probable and confirmed cases, which were associated with four deaths. Thanks to the rapid and effective response coordinated by the World Health Organization (WHO) and its partners, the outbreak appears to have been brought under control. That’s a huge relief. But does that mean our toolbox is indeed adequately equipped to combat the virus? What if EVD, which kills 25 to 90 percent of those who become infected, again spread like wildfire? To address these questions, the story of China’s efforts to develop anti-Ebola drugs is illustrative of the opportunities and challenges we face in ensuring global health security. In August 2014, when Ebola virus was wreaking havoc in West Africa, the People’s Liberation Army’s (PLA’s) Academy of Military Medical Science (AMMS) announced that it had successfully developed jk-05, China’s first drug for treating EVD. The chemical formula of jk-05 remains not fully disclosed; all we know is that it is a small-molecule drug with a relatively simple structure, which should be amenable to mass production if testing proves successful. The lack of public information about the drug makes it difficult to assess its efficacy. The drug is said to have passed evaluation by PLA health experts, but it was clear that when that news came out the drug was still at an early stage of development. Not surprisingly, jk-05 was approved as a special drug for military needs and for emergency use only. That has not deterred Sihuan Pharmaceutical, originally affiliated with AMMS and now one of China’s leading generic pharmaceutical companies, from announcing in October that it had purchased the rights to commercialize jk-05 and would develop it into a broad-spectrum antiviral drug. Meanwhile, the Chinese military shipped thousands of doses of jk-05 to West Africa for treating potential infections of Chinese health workers and potentially conducting clinical trial. But according to the WHO, jk-05 was likely a copycat product of favipiravir (T-705), an anti-influenza drug developed by Fujifilm Holdings Corp. of Japan. It was reported that the Japanese company, which registered favipiravir in China in 2006, suspected that AMMS used the patent information to develop jk-05 and demanded China to investigate this issue. As a repurposed drug, favipiravir appears to be effective against EVD in a mouse model, but its efficacy against human Ebola infection is unproved. A retrospective clinical case series was performed by Chinese scientists for EVD patients in the Sierra Leone-China Friendship Hospital in October–November 2014. It was found that the overall survival rate in the group treated with favipiravir was higher than that of the control group, but the limited sample size precluded any strong conclusions. Another subsequent and more robust clinical study by Doctors Without Borders (MSF) could not reach a conclusion about the efficacy of the drug because the number of enrolled patients was ultimately too small. Interestingly, MSF was not aware that China had used favipiravir in Sierra Leone when MSF itself was planning to test the very same drug in Guinea in December 2014. This lack of collaboration was a missed opportunity to draw strong conclusions on favipiravir, as the two projects used non-comparable methodologies. The fate of jk-05/favipiravir highlights the role of ZMapp, an experimental drug developed by U.S.-based Mapp Biopharmaceutical, as the most promising treatment against Ebola. Access to the drug was nevertheless difficult despite the urgent need to scale up production during the West African outbreak. The drug is produced in tobacco cells whose yield is low, so a limited supply of ZMapp was quickly exhausted in the fall of 2014. At the time, scientists at AMMS and a small private Chinese company, Beijing Mabworks, used information in ZMapp’s patent to copy the active part of the drug and produce a therapeutic chimeric antibody agent, MIL-77. Even though the Chinese cocktail is similar to ZMapp in terms of the antibodies used, it is amenable to large-scale production via mammalian cell expression. With the help of the Chinese pharmaceutical firm Hisun, which had developed four mammalian cell production lines, Mabworks produced about 100 doses of MIL-77 by the end of the year. The drug was reported to have successfully treated a British military nurse who contracted Ebola while serving in Sierra Leone. Given China’s robust bio-manufacturing capabilities and the relatively low cost of producing the drug in the country, rapid scale-up of the (then) most promising treatment against EVD seemed no longer a dream. Mabworks discussed with MSF possible donations of a dozen treatments for compassionate use. However, as the Phase 1 study of MIL-77 in healthy volunteers had not yet been conducted, export of the product from China was challenging. There was another problem: the drug comprises three chimeric monoclonal antibodies, two of which were originally developed with support from U.S. and Canadian military research agencies. Put differently, the U.S. government and Her Majesty the Queen in Right of Canada hold patents for two of the antibodies in ZMapp. As a result, some American government officials have expressed patent infringement concerns. In 2015, Mabworks signed an agreement with Mapp Bio, the license-holder of ZMapp. Similar to China’s international marketing experience with artemisinin, Mapp Bio acquired the rights to market MIL-77 worldwide except in China. While China was able to produce thousands of doses of MIL-77 within a short period of time, Mapp Bio was not keen on further developing the Chinese biosimilar. Meanwhile, as the Ebola epidemics burned out, a clinical study on ZMapp was conducted but could not reach significant results because of the difficulty of recruiting patients (only seventy were enrolled for the study by the end of 2015). So we are back to square one: according to Julien Potet of MSF, the only ZMapp-like product that is available today is the original tobacco cell-derived ZMapp; only 100 doses of treatments are available for an Ebola outbreak. The tale of the two Chinese-developed anti-Ebola drugs has revealed the possibilities and problems pharmaceutical industries of emerging economies face in contributing to global health security. As shown by Mabworks’ ability to rapidly produce a biosimilar of ZMapp, pharmaceutical molecularization creates opportunities for China to catch up technologically with industrialized countries in developing medical countermeasures efficiently and effectively to address major disease outbreaks. Framing infectious disease as a security challenge also enabled military actors such as AMMS, which was established to prepare for biological warfare, to play a prominent role in this process. That Chinese scientists and pharmaceutical firms could work together with their counterparts in the United States and Canada also shows the potential of North-South cooperation in the development and distribution of lifesaving drugs. But does this suggest a paradigm shift? Is China becoming a game-changer in global health security? The fact that the development of both jk-05 and MIL-77 primarily relied on previous research done elsewhere indicates that China’s ability to offer original, innovative solutions remains in question despite having a strong pharmaceutical industry. It was challenging for China and MSF to cooperate, showing that a siloed approach continues to prevent China from working with non-state actors in drug research and development. Unfortunately, intellectual property issues remain an insurmountable hurdle for China to scale up the production of MIL-77 and serve as a real leader in this area. New norms and rules will be needed to balance public health and intellectual property considerations in pursuing and promoting global health security.

Rachel Brown, Ashley Feng, Douglas Mo, and Gabriel Walker look at the top stories in Asia this week.

In one of my recent blog posts on the World Health Organization (WHO) director general (DG) election, I discussed how the new election procedure has reduced the advantage larger states have in influencing election outcomes. Still, since health is a “highly politicized” topic, competition for the job involves deal-making and horse-trading that allow a complex set of factors (e.g., geopolitical considerations) to decide who will be the final winner. In this process, major powers can exert significant influence in part because they have more non-health-related bargaining chips than smaller nations to use in the negotiations. This might explain why days before the WHO election Dr. David Nabarro was campaigning in Beijing, busy meeting with Chinese health and foreign affairs officials, giving interviews to local media, and delivering a speech at the prestigious Tsinghua University. China at the time was very likely debating whether to throw its support behind him or Dr. Tedros Adhanom, former Ethiopian minister of health and minister of foreign affairs. As early as March, Dr. Tedros was invited to visit China where he delivered a keynote speech at Peking University. The political entity that felt left out of the party was Taiwan, which viewed formal participation at the World Health Assembly (the WHO’s executive body) as a critical step in its quest for international recognition. Under President Ma Ying-jeou, who served in that capacity between 2008 and 2016, Taiwan was able to participate as an observer under the title “Chinese Taipei.” The invitation arrived at the last minute last year, apparently as a warning sign from mainland China against the newly elected pro-independence President Tsai Ing-wen. This year, China was convinced that Tsai’s government had no intention of following the so-called “1992 Consensus,” which dictates that both Taiwan and mainland China are inalienable parts of a single entity, though each side has a different interpretation of what that entity is. Under pressure from China, the WHO secretariat did not issue an invitation to Taiwan. Dismayed and disappointed, Taiwan lobbied eleven of its twenty-one diplomatic allies to raise a motion calling for Taiwan’s inclusion at the WHA. The motion was deleted from the agenda when the WHA met on May 22, dashing any hopes that Taiwan could secure representation at the meeting. Interestingly, in its WHA bid Taiwan was advised to lobby its allies to vote for Nabarro, who was believed to be “nicer to Taiwan.” This kind of wishful thinking only did a disservice to Nabarro’s campaign: while both candidates sought to befriend China, Tedros now seemed to be a more favorable choice to China. Like Margaret Chan, the current WHO DG, Tedros was keenly aware of the importance of the Taiwan issue in WHO’s relationship with China. The day after his electoral victory, he reiterated his adherence to the “One China” principle (read: WHO will not invite Taiwan for formal participation without China’s approval). What about the United States, the largest funder of the WHO? As my colleague Laurie Garrett observed, Tedros was the favorite candidate of the Obama administration, but was not the Trump administration’s first choice. This is in part because Tedros’s focus on universal health coverage ran counter to U.S. Secretary of Health and Human Services Tom Price’s interest in global health security. But the U.S. preference was not echoed by developing countries, which voted overwhelmingly in favor of Tedros. While the WHA was in session, the Trump administration unveiled its proposed budget, which would cut the annual global health budget by about 26 percent. The massive cut in global health funding would not only pose existential challenges to specific global health programs, including those related to family planning, malaria, and HIV/AIDS, but also risk fulfillment for WHO’s overall budget, exacerbating the international agency’s funding crisis. By contrast, China’s top health official bragged that 2017 would bring a “bumper crop” for its global health engagement: in January, it signed a MOU with the WHO for cooperation on the One Belt, One Road initiative; in March, it opened the Global Health Drug Discovery Institute, a partnership with the Gates Foundation that focuses on early drug discovery to fight HIV, tuberculosis, and malaria; in April, it co-chaired the China-Africa Health Ministers Conference, committing itself to “multilateralism and a rules-based global health governance mechanism”; in May, President Xi Jinping hosted the Belt and Road Forum for International Cooperation, during which he pledged 60 billion RMB ($8.8 billion) to developing countries and international organizations participating in the initiative to launch more projects to improve people’s well-being worldwide; in July, China will host the BRICS Health Ministers Conference; and in August, a high-level forum will be held in Beijing to discuss global health cooperation. With China’s rapid advancement in global health and U.S. retreat from this area, we will see a WHO increasingly looking toward China for leadership.

Rachel Brown is a research associate in Asia Studies at the Council on Foreign Relations. The pageantry at last month’s Belt and Road Forum in Beijing highlighted the two major prongs of China’s Belt and Road Initiative: the Silk Road Economic Belt, which runs through Central Asia to Europe, and the 21st Century Maritime Silk Road, which runs through Southeast Asia, Africa, and Europe.  But a third prong of the initiative – the “digital new silk road” or “information silk road” – received less attention. Yet this component could generate significant consequences. The idea of incorporating digital sectors like telecommunications, internet of things infrastructure, and e-commerce into One Belt, One Road (OBOR) is not new. The March 2015 white paper articulating the vision for OBOR called for growth in digital trade and the expansion of communications networks to develop “an information silk road”. A few months later, Lu Wei, then director of the Cyberspace Administration of China, told the China-EU digital cooperation roundtable that, “We can build a digital silk road, a silk road in cyberspace”. The concept even received a shout out in the joint communiqué from the recent Belt and Road Forum, with a pledge to support “innovation action plans for e-commerce, digital economy, smart cities and science and technology parks.” But outside the bland formulations of policy documents, what will the digital new silk road actually look like? Many aspects of the concept are a natural extension of the “going out” policies pursued by Chinese telecommunications companies and could fill unmet needs for digital connectivity; greater connectivity could in turn open new markets for Chinese firms in e-commerce and other areas. But overall, the digital new silk road looks less like a cohesive concept and more like a catchall phrase applied to everything from earth observation projects at the Chinese Academy of Sciences to cell phone sales by Xiaomi. So are companies and officials simply paying lip service to Xi Jinping’s One Belt, One Road vision when they speak of the digital new silk road or is there the potential for something more? The three sectors below offer insights into the ambitions for – and possible pitfalls of – OBOR’s third prong: 1. Telecommunications and Satellites In addition to new railways, ports, and power plants, another infrastructure priority under OBOR is improving “international communications connectivity” through “the construction of cross-border optical cables and other communications trunk line networks”. State-owned enterprises including China Telecom, China Unicom, and China Mobile have already embarked on OBOR-related projects and are building out the infrastructure to underlie the digital new silk road. Among the ambitious programs are the construction by China and Russia of overland cable links between Asia and Europe. Private companies like Huawei and ZTE have also gotten into the game with projects including a fiber optic cable network in Afghanistan. In addition to cable networks, OBOR also offers the Chinese government a chance to encourage the adoption of its Beidou satellite network, a competitor to GPS, through a “space-based silk road”. The government aims to roll out basic services along the Belt and Road route by 2018 and the State Council Information Office is promoting Beidou’s use in everything from power transmission to transportation. Already, limited use of Beidou has been piloted in Karachi, Pakistan. These new projects will not only enhance digital connectivity in underserved Central and Southeast Asian countries but also facilitate faster and easier to maintain data connections. However, telecommunications cables built by China and Russia could also lead to network splintering if countries seek to insulate their data from traveling through the United States or Europe due to surveillance fears. Additionally, while the expansion of the Beidou system could improve the accuracy of consumer satellite navigation, it could also squeeze foreign companies out of satellite navigation markets in China and certain OBOR nations. Beidou’s development could also have implications in the national security realm as the People’s Liberation Army improves its weapons and tracking capabilities. 2. Smart Cities Another digital infrastructure frontier for Chinese firms is the construction of “smart cities”. Smart cities are broadly defined as urban areas that integrate information and communications technology to improve city operations in everything from traffic flows to water conservation to crime prevention. In recent years, ZTE and Huawei have expanded their efforts to supply smart city projects in OBOR nations such as Malaysia, Kenya, and Germany. Even China’s model smart city, Yinchuan, lies along the path of the path of the original silk road in a region now poised to benefit from new trade routes. Yinchuan offers citizens an array of innovative services including access to city information via QR codes and the ability to pay bus fares upon boarding through facial recognition software. Last December, ZTE’s chief information and strategy officer, Chen Jie, stressed the company’s commitment to sharing its smart cities know-how across the OBOR route. One of the company’s subsidiaries, ZTEsoft, has even co-opted the Belt and Road name for its new initiative the “Data Belt, Information Road”. The program will work with Singapore’s StarHub telecommunications to promote cross-border collaboration on smart city development, operations, and technology. Such collaborations could help modernize cities, increase their efficiency, and promote greater standardization of technologies.  However, the increasing reliance of cities on technology also raises cybersecurity risks given the susceptibility of internet of things devices to hacking. Moreover, for countries with often tense relationships with China, there could be broader worries about depending on digital infrastructure supplied by Chinese firms. For example, the City of Pearl, a planned “city within a city” in Manila, is being touted as the largest OBOR project in the Philippines. The project aims to integrate artificial intelligence to regulate city functions, but will be built by the Hong Kong and mainland China-affiliated UAA Kinming Group, which could raise security concerns. 3. E-Commerce Increased internet connectivity could also pave the way for more Chinese e-commerce sales along the Belt and Road route. Two of China’s e-commerce giants – Alibaba and JD.com – have already sought to link their global expansion to OBOR. According to Xinhua, JD.com plans to set up “more than 20 overseas warehouses to store and transfer goods from over 100 countries and regions including those along the Belt and Road Initiative.” Alibaba founder Jack Ma has cited countries along the OBOR route as among the most important regions for his company and plans further expansion in Russia, Central Asia, and Southeast Asia. This year, the company went even further and partnered with the Malaysian government to establish the first “digital free-trade zone”. The project will offer logistics and fulfillment capabilities as well as an online services platform. At the free trade zone’s launch, Ma argued that, “For human beings the first globalization was the silk road... today in the internet [age], I think we should transfer the silk road to an e-road”. This is a common refrain from Ma, who has argued for integrating standards and reducing trade barriers in e-commerce via an “electronic world trade platform”. Ma’s dream of promoting greater global online trade is consistent with OBOR’s mission of expanding commerce along new routes. But despite their apparent enthusiasm, Chinese e-commerce firms could become disillusioned in certain Belt and Road nations as they face competition from local firms, infrastructure challenges, and regulatory obstacles. OBOR projects may smooth some existing challenges such as limited shipping routes and high-speed broadband access, but other impediments will remain including customs policies and a lack of trust regarding e-commerce fulfillment. Given these hurdles, companies may not make money right away. But Ma appears willing to play a long game with his international e-commerce ambitions, much like Chinese leaders themselves with the entire OBOR project.  Surveying the digital landscape under the auspices of One Belt, One Road, many projects still appear linked by political rhetoric rather than a coherent strategy. But if the digital new silk road overcomes the challenges highlighted above and emerges as more than a catchy phrase, it will be an important step in knitting other countries into Chinese networks and could limit the influence of  the U.S. government and multinationals strategically and economically.

One key question around China is pretty straight forward: will losses in China’s banks and shadow banks—whether on their lending to Chinese firms or their lending to investment vehicles of local governments* necessarily give rise to a currency crisis? Or can China, in some sense, experience a banking crisis—or at least foot the bill for legacy bad loans—without a further slide in the yuan (whether against the dollar or against a basket)? To answer this question I think it helps to review the reasons why banking crises and currency crises can be correlated, and to see what vulnerabilities are and are not present in China. The first reason why a banking crisis can lead to a currency crisis is simple: the banks have financed their lending boom by borrowing from the rest of the world, and the rest of the world decides the banks are too risky and wants its money back. The need to repay external creditors leads the country to exhaust its foreign exchange reserves, and ultimately, without reserves, the country is forced to devalue. Thailand in 1997 is probably the best example. This risk simply is not present in China. China has more external reserves than it has external debt, let alone short-term external debt. China's lending boom hasn’t been financed by the world—it has been financed out of China’s own savings, intermediated through Chinese financial institutions. The second reason is also straightforward: losses in the banks and shadow banks could lead Chinese residents to pull their funds out of China’s financial system, and seek safety offshore.  This no doubt could happen—though China’s financial controls are meant to limit this risk. China—like other big countries—doesn’t have enough reserves on hand to cover all its domestic bank deposits, let alone the shadow banking system’s analogue to “deposits.” And while some deposit flight can be financed out of China’s existing trade surplus, it is certainly possible to imagine more flight than could be financed out of China's exports.   On the other hand, losses in China’s domestic banking system will not necessarily result in a run into offshore deposits. The system may be recapitalized before there is a run. Or those who flee the shadow banking system might move their funds into China’s banks, not into foreign deposits. Or those who flee China’s risker mid-tier banks might run to the safety of the big state commercial banks (effectively running out of institutions backed by weak provincial government balance sheets to institutions backed by the much stronger balance sheet of the central government).   But a run out of all Chinese bank deposits is a risk, both to China and the world. It is in some sense is the flip side of China’s lack of external vulnerability: very high domestic savings intermediated through domestic financial institutions means a ton of domestic deposits and shadow deposits. And limiting this risk is a big reason why I believe China needs to be cautious in liberalizing its financial account. The third reason is that China’s government might not be able to cover the cost of recapitalizing its banks, and the government—not the banks per se—might need to turn to the central bank for financing. This is one of the risks that Christopher Balding highlights for example (more here). And while it is a risk, I don’t think it is a big risk.    A bank doesn’t actually have to be recapitalized with cash. It can be recapitalized with government bonds (see Jan Musschoot for the mechanics, or look at this IMF paper). Say a bank writes down the value of its existing loans, and that loss wipes out its equity capital. The government can exchange government bonds for “new” equity in the bank.    It doesn’t have to go out into the market and sell bonds and hand the cash over to the bank.   An asset management company can also be funded in the same way: the government can swap newly issued government bonds directly for a portfolio of bad loans (and hand the bad loans over to an asset management company to try to recover something). This raises the government’s stock of debt, but it doesn’t require raising cash and handing the cash over to the bank in exchange for a portfolio of bad loans. It also doesn't require making use of the central bank's balance sheet.**   And even if the government wants to recapitalize its banks by handing the banks cash in exchange for either new equity or for bad debts, it can raise the cash by issuing bonds in the market—that doesn’t require a monetary expansion either, though it can put upward pressure on interest rates. The IMF's 2016 estimate of bank losses on corporate credit (7 percent of China's GDP) may be too low, but if it is close to right, it is not a sum that China would have trouble funding.*** To be clear, if a recapitalized bank experiences a run, the bank will need to take the government bonds it has received from the government to the central bank and borrow cash against its “good” collateral (or not-so-good collateral; I agree with Balding's World that a no-recourse loan against bad collateral is a backdoor bank recapitalization through the central bank). But it is the run that gives rise to the need “to print” money, not the recapitalization. And the money provided to depositors fleeing a troubled institution often ends up in other institutions—it doesn’t necessarily leave the system. The central bank can mop up liquidity provided to a troubled institution by withdrawing liquidity elsewhere, with no change in its monetary policy stance. One additional point here: a preemptive recapitalization which adds to the system’s capital and allows some shadow banking liabilities to migrate on-balance sheet would in my view reduce the risk of a run—as it would be clear that the recapitalized institutions would be able to absorb losses without passing the losses on to depositors. It thus in my view reduces the risk that the banking system's legacy bad loans would lead to a monetary expansion that jeopardizes currency stability.  The fourth reason why a banking crisis can lead to a currency depreciation is that the banking crisis leads to a slowdown in growth—and in response to the slowdown in growth, the central bank may need to ease monetary policy. Capital controls can give a country with a currency peg a bit more space to keep its currency stable without following the monetary policy of its anchor currency (or for a basket its anchor currencies). For example, for much of the last 15 years, China has been able to have a tighter monetary policy—or at least higher lending rates—than the United States without being overwhelmed by inflows (from 2003 to 2013, China’s challenge was limiting inflows, not outflows). But there is a limit to how much any country, even China, can ease monetary policy while maintaining a stable exchange rate, especially if China is managing its currency against the dollar, and the U.S. is tightening monetary policy. China’s controls can make it significantly harder to swap yuan for dollars or euros, but they are likely to work best if the controls are reinforced by a positive interest rate differential. Here too China has options. It could respond to a slowdown in growth by easing fiscal policy without easing monetary policy, maintaining an interest rate differential that would encourage Chinese residents to keep their funds in China.***  And that could maintain demand—taking pressure off the central bank. In any case, the PBOC is now tightening monetary policy to slow the economy, so this is a theoretic rather than a current risk.**** While there is a path out of China’s current banking troubles that doesn’t involve a further depreciation, there isn’t a path out of China’s current difficulties that doesn’t involve the use of the central government’s balance sheet. *****    Let me offer up an imperfect analogy—imperfect both because it involves a currency union that isn’t a full political union, and even more imperfect because it involves a currency that floats, not a peg. Ignore it if you want, my argument doesn’t depend on it. Before its crisis the eurozone ran a balanced current account. The current account deficits of countries like Greece, Ireland, and Spain were essentially financed (in euros) by German and Dutch current account surpluses, not by borrowing from the rest of the world. And the run out of Greek, Irish, and Spanish banks in 2010 and 2011 was largely a run into safe assets in the eurozone’s core, not a run out of the euro. That all was a big reason why the euro didn’t depreciate significantly in the early phases of the eurozone’s crisis, despite violent swings in financial flows inside the eurozone. Keeping the eurozone together required the ECB act as a lender of last resort (essentially borrowing from German banks to lend to Spanish and Italian banks through the target 2 system to offset the withdrawal of private financing from the periphery) and that the eurozone create common institutions (EFSF, ESM) to help weaker countries finance the cost of bank recapitalization. But the ECB’s provision of lender of last resort financing to banks in troubled countries on its own did not drive the euro down.   The euro ultimately did fall in 2014 because the ECB needed a looser monetary policy to support overall eurozone demand (negative rates, QE, etc). If the eurozone as a whole had relied more on fiscal rather than monetary easing to rebuild demand, the ECB wouldn’t have needed to ease quite as much—and the eurozone today would have a smaller current account surplus.  I think there is a parallel: China’s shadow banks and some mid-tier banks are the periphery, relying on funding from China’s core (so to speak). A run back to the core is no doubt a significant problem. But it also is something that conceptually China has the resources to manage without necessarily needing a weaker currency and more support for its growth from net exports.   * China’s central government's credit risk is low; central government debt is low—and lending to Chinese households also isn’t generally believed to pose a problem. ** The asset management companies (AMCs) that were set up to clean up the balance sheets of the major state commercial banks initially had this structure: the banks handed over their bad loans to the AMCs, and got a bond that the AMCs issued in exchange. The AMC bond was never explicitly guaranteed, so technically it wasn’t the government’s debt. But the government pretty clearly was going to stand behind the AMC loans. There was no direct need to use the PBOC’s balance sheet in this transaction. Christopher Balding notes that the central bank can also provide liquidity directly to the banks against dodgy collateral, and thus lift bad loans directly off a troubled bank's balance sheet (either by buying the bad loan, or by providing a no-recourse loan against the loan). That is no doubt true: China has been known to hide the cost of a bailout by in effect netting it against the central bank's ongoing profits in a less than transparent way. But the orthodox way of structuring an AMC would use the Ministry of Finance's balance sheet, and the central bank would lend against recapitalization bonds or AMC bonds with a guarantee not directly against bad collateral. And any injection of liquidity to a troubled bank would be offset by withdrawing liquidity elsewhere. For those interested in the details of China's recapitalization of the big state banks, there is no better source than Red Capitalism.    *** China is now big enough that a slowdown in its growth affects growth elsewhere, and thus monetary easing by China's partners also might play a role in maintaining the interest rate differential. In 2016 for example, risks around China seem to have contributed to the Fed's decision to slow its pace of tightening. **** A couple of additional technical points here. In 2015 and in early 2016, the PBOC was loosening policy not tightening policy (cutting rates, reducing the reserve requirement and so on). That added to the pressure on China's currency. And with reserves falling, the PBOC needed to buy domestic assets (or increase its domestic lending) to keep its balance sheet from shrinking. Its overall monetary policy stance consequently cannot be inferred by looking only at its domestic balance sheet. ***** A restructuring of local government debt also does not require the use of the central bank's balance sheet. For example the central government could swap a Ministry of Finance bond for provincial debt, leaving the market (read banks and shadow banks) with a claim on the central government and leaving it to the central government to collect on provincial debt.  

   

Margaret K. Lewis is a professor of law at Seton Hall University School of Law and a Fulbright research fellow at National Taiwan University School of Law. As the world reflects on this week’s anniversary of the Tiananmen Square protests and subsequent violent crackdown by the PRC government, it is worth contemplating what President Donald J. Trump would do if faced with a similar situation. When asked about Tiananmen during the campaign, Trump said he was not “endorsing” China’s response, but he called the demonstrations a “riot.” Would President Trump see a riot or a massacre if the events of June 4, 1989, were replayed today? The U.S. bombing raid in April that President Trump linked to the Syrian government’s use of chemical weapons against civilians suggested that human rights would be prominent in shaping foreign policy. Yet President Trump’s remarks during his recent visit to Saudi Arabia and praise for leaders with deeply problematic human rights records, such as Egyptian President Abdel Fattah al-Sisi, caution otherwise. Specifically regarding China, in March 2016 the Obama administration joined eleven other countries in issuing a rare statement expressing “concern[ ] about China’s deteriorating human rights record” and calling on China “to uphold its laws and its international commitments.” The United States was noticeably absent a year later when eleven countries—including Canada, Australia, and the United Kingdom—sent a letter to the Chinese government expressing “growing concern over recent claims of torture and other cruel, inhuman or degrading treatment or punishment in cases concerning detained human rights lawyers and other human rights defenders.” The Trump administration is admittedly not breaking the mold: U.S. government policy towards China has always been, at least to some degree, pragmatic. President Jimmy Carter entered office with human rights as a cornerstone of his foreign policy. Nonetheless, even he recognized the United States’ many interests when dealing with China and normalized relations. President George H. W. Bush suspended military contracts and technology exchanges with China following the Tiananmen Square massacre. President Bill Clinton, however, restored China’s most favored nation trading status four years later and quickly relaxed rhetoric that China must make significant progress towards conforming with international human rights standards. While the tension between principles and pragmatism is not new in U.S. policy towards China, the current dismissive attitude towards human rights is jarring. The past four months indicate that policy decisions based on immediate economic and security calculations will prevail over long-held human rights values. As I have argued elsewhere, this is a mistake. Addressing human rights in both a principled and pragmatic way requires not just stating that human rights matter in the abstract but also articulating an integrated, executive-branch-wide plan for how human rights will be raised in various contexts. Secretary of State Rex Tillerson opened the door for such an approach in his April 7, 2017, briefing when a dedicated human rights dialogue was conspicuously absent from the announced list of bilateral dialogues. When asked whether the United States would pressure China on human rights violations, Secretary Tillerson responded that he did not think there needed to be a separate conversation on human rights because “[t]hey’re really embedded in every discussion, that [ ] is really what guides much of our view around how we’re going to work together.” What remains to be seen as the revamped dialogues take shape is whether human rights will be embedded in the sense of integral or, in contrast, embedded in the sense of hidden like an unseen fossil encased in stone. Will freedom of expression be a central component of discussions regarding cybersecurity? And will protections for the accused be at the forefront of conversations regarding repatriating fugitives as part of bilateral law enforcement efforts? Admittedly, even if President Trump raises the priority of human rights on the bilateral agenda, it would not be a panacea. Chinese President Xi Jinping has rebuffed foreign pressure, including a scathing rebuke by the UN Committee Against Torture as part of the PRC’s periodic review of its implementation of the Convention against Torture and Other Cruel, Inhuman or Degrading Treatment or Punishment. PRC government intransigence is, however, not reason to throw in the towel. First, U.S. government involvement can be critical in specific cases. The Trump administration deserves kudos for facilitating the return of American citizen Sandy Phan-Gillis after her prolonged arbitrary detention by the PRC government. Second, condemnation of human rights abuses can help hearten people in China who have seen their rights, as well as those of friends and family, violated. Third, beyond individual cases, building interpersonal ties by engaging Chinese officials and members of civil society in conversations regarding human rights lays the groundwork for more substantive long-term cooperation after the current political winds shift, whenever that may be. Finally, taking a principled stance on human rights signals to the world that the United States is indeed standing behind core human rights values as we struggle to regain our moral authority in the wake of glaring abuses committed as part of the “war on terror.” Let us hope that President Trump will not confront a tragedy on the scale of 1989. But the Trump administration must grapple with the ongoing human rights violations in China. In doing so, it should not let its acts be driven by pragmatism at the expense of principles. As exhorted by Chinese artist and activist Ai Weiwei, “Your own acts tell the world who you are and what kind of society you think it should be.”