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C O N F I D E N T I A L SECTION 01 OF 04 HONG KONG 001285 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EAP/CM AND EB 
DEPARTMENT PASS H 
STATE PASS USTR 
USDOC FOR DAS LEVINE, ITA/OCEA MCQUEEN AND CELICO 
TREASURY FOR LOEVINGER AND KOEPKE 
NSC FOR WILDER, SHIRZAD 
 
E.O. 12958: DECL: 03/27/2031 
TAGS: PREL ETRD EFIN WTRO PGOV OREP HK CH
SUBJECT: CODEL GRAHAM FOCUSES ON CURRENCY AND PORT SECURITY 
 
Classified By: EP Section Chief Simon Schuchat; Reasons 1.4 (b/d) 
 
 
SUMMARY 
------- 
 
¶1. (C) Renminbi (RMB) valuation, port security, and mainland 
urban/rural disparity dominated the March 25-26 visit to Hong 
Kong of Senators Lindsey Graham and Charles Schumer.  Hong 
Kong Monetary Authority Chief Executive Joseph Yam encouraged 
the Senators to continue pressing the mainland to liberalize 
currency policy but cautioned against seeking excessively 
rapid changes that would destabilize China's financial system 
and thereby harm the global economy.  Hong Kong's former 
Chief Executive C.H. Tung counseled patience concerning 
financial liberalization, citing the rapid pace of China's 
economic reforms in recent years and underscoring the 
challenges posed to PRC leaders by growing income disparity 
and continued high rates of bad loans in the banking system. 
Seven financial strategists generally agreed that the 
renminbi (RMB) is significantly undervalued but assessed that 
the mechanics and political constraints faced by China rule 
out a quick resolution of the currency question.  A 
demonstration of a pilot comprehensive container screening 
system enabled Hutchison Port Holdings to highlight for the 
Senators the degree to which global port operators are now 80 
percent concentrated around firms from Hong Kong, Singapore, 
Dubai, and Denmark -- with implications for U.S. policy 
makers as they decide on how to engage the world on port 
security issues; the demonstration was followed by a visit to 
the Container Security Initiative (CSI) operations here. 
Local business leaders expressed concerns about the potential 
for instability on the mainland as resentment grows over 
corruption, land seizures, and income disparities -- all 
amidst increasingly free-flowing information, Internet 
restrictions notwithstanding.  The International Republican 
Institute Resident Representative described the awkward 
balance that IRI must strike as a foreign NGO operating in 
China.  END SUMMARY 
 
VISIT DETAILS 
------------- 
 
¶2. (SBU) Senators Lindsey Graham (R-SC) and Charles Schumer 
(D-NY) visited Hong Kong March 25-26 after traveling to 
Beijing and Shanghai.  Accompanying the Senators were: 
 
o Matt Rimkunas, Legislative Assistant (Graham) 
o Kevin Bishop, Communications Director (Graham) 
o Jeff Haymond, Legislative Assistant (Schumer) 
o Risa Heller, Press Secretary (Schumer) 
o CDR Steve Vahsen, Military Escort 
 
The Senators held the following substantive meetings (in 
order of agenda): 
 
o C.H. Tung, Former Chief Executive of Hong Kong 
o Joseph Yam, Chief Executive, Hong Kong Monetary Authority 
  (HKMA) 
o Visit to Integrated Container Inspection System (ICIS) 
  Pilot Demonstration 
o Visit to Container Security Initiative (CSI) Operations 
o Dinner hosted by the Better Hong Kong Foundation (BHKF) 
o Amy Gadsden, Resident Representative, International 
  Republican Institute (IRI) (Graham Only) 
o Gathering with Financial Strategists (Graham Only) 
 
HKMA: KEEP PUSHING, BUT CAREFULLY 
--------------------------------- 
 
¶3. (C) HKMA's Yam assessed the mainland's movement towards a 
more liberal financial system as understandably cautious.  He 
made clear that Hong Kong sees it in its own interest for 
some elements of currency reform to move more quickly, 
particularly those aspects that might allow the city to 
benefit from expanded offshore RMB-related services.  The HKG 
has made known to Beijing its interest in such an accelerated 
pace.  Yam said the existing leadership is "unfortunately" 
slow in moving forward, in part because Premier Wen Jiabao is 
a consensus builder.  People's Bank of China (PBOC) Governor 
Zhou Xiaochuan understands that excess accumulation of 
foreign exchange reserves implies that the time is now for 
bolder steps forward on the RMB, but Premier Wen is not "100 
 
HONG KONG 00001285  002 OF 004 
 
 
percent there," and Zhou's bureaucratic influence is limited. 
 "If it was just Zhou, you'd be there," he said.  Although 
Vice Premier Wu Yi met with the Senators in China and clearly 
impressed them, Yam commented that her responsibilities and 
knowledge with regard to reform of the financial system are 
limited. 
 
¶4. (C) Yam said that slow liberalization of the currency 
system deprives China of access to services that would help 
channel funds in the most productive ways possible.  Capital 
controls prevent money from flowing out of China to places 
like Hong Kong where talented intermediaries could put the 
funds to their best use.  Yam observed that mainland 
investors are forced to invest domestically and are thus 
unable to purchase the financial instruments (listed stocks, 
bonds) of Chinese firms that obtain finance here.  Beijing 
fully appreciates the importance of the financial system for 
growth and development but is very concerned about stability 
and thus remains cautious about moving forward.  The 
leadership is now confronted by strains caused by rapid 
development (e.g., rioting in villages where land has been 
seized, mining accidents).  While the U.S. should by all 
means continue to put political pressure on China, it is 
important to understand the downside risks should reform 
trigger disorderly adjustments.  Further, although the 
Senators' proposed tariff legislation would not take effect 
for two years, markets could "telescope" the impact by 
reacting immediately. 
 
¶5. (C) Yam said he was not sure whether the leadership in 
Beijing looked to Hong Kong as a place for experimenting with 
China's political direction.  However, this is certainly the 
case on the economic side as is already evidenced by existing 
permissions granted for banks in Hong Kong to conduct limited 
RMB business.  (Note: This includes RMB conversions, 
remittances, deposits, and transfers, but not loans or the 
issuance of RMB-denominated financial instruments.  End Note.) 
 
¶6. (C) Senator Graham told Yam that he had drawn several 
conclusions so far on his trip to China and Hong Kong: China 
faces major challenges as it deals with growing income gaps 
between rich and poor; the 3 percent RMB appreciation since 
last July does not represent real reform but instead China's 
desire to avoid political conflict; China needs to take 
actions that will instill confidence that market disruptions 
caused by currency policy will be addressed; and the currency 
issue can be resolved in a win-win manner that can take us 
all to the next level of globalization.  Senator Schumer told 
Yam that the currency question -- unlike intellectual 
property rights protection -- is something that the PRC 
central government has within its power to address now.  He 
contrasted China's high savings/low consumption rates with 
the mirror image found in the U.S., concluding that changing 
the patterns found in both countries will be ultimately be 
part of the solution. 
 
FORMER CHIEF EXECUTIVE: AVOID SHOCK THERAPY 
------------------------------------------- 
 
¶7. (C) C.H. Tung said that China's greatest challenge is 
managing urbanization as income disparity rises.  This 
includes dealing with environmental degradation, addressing 
anger among the poor at issues such as land seizures, and 
providing a social safety net.  Such issues compel Beijing to 
seek internal stability and a "peaceful globe" above all 
else.  He encouraged the Senators to look at how fast China 
had changed in recent years and implored them not to judge 
China by the standards of U.S. democratic and economic 
development.  Tung cited banking system reforms to date, 
compliance with WTO obligations, and rapidly growing imports 
as reasons to be more tolerant of China's pace of economic 
liberalization.  He warned of financial instability should 
China move too quickly and asked that the Senators not try to 
"force shock therapy" on the PRC.  Tung also spent a few 
minutes noting the importance to Beijing of the Taiwan 
question -- their number one issue -- and assessed Taipei 
Mayor Ma Ying-jeou -- a possible presidential candidate for 
the Kuomintang in 2008 -- as someone who could bring a hope 
of stability, unlike current President Chen Shui-bian who, in 
Tung's words, is "trying to be relevant" by pushing towards 
independence. 
 
¶8. (C) Senator Schumer expressed concern that China is not 
 
HONG KONG 00001285  003 OF 004 
 
 
opening up its financial services sector quickly enough. 
Noting barriers to market access for Visa-branded credit 
cards, the Senator wondered aloud whether China is truly open 
to obtaining the best services and technology relevant to its 
development or whether it is trying to learn from the U.S. 
and then create a situation where its firms copy American 
practices but retain dominant access to the local market. 
Tung answered that the mainland's focus is bringing in 
investment and expertise from whatever source, and that this 
can be seen through the listing, for example, of Chinese 
banks in Hong Kong, a process that is occurring outside of 
the domestic economy and involves a wide range of foreign 
service providers and strategic investment partners. 
 
INVESTMENT BANK ECONOMISTS: CURRENCY REFORM WILL TAKE TIME 
--------------------------------------------- ------------- 
 
¶9. (C) Seven investment bank economists, all of whom held 
titles indicating a chief economist role involving China, 
generally agreed with Senator Graham's assertion that the RMB 
is undervalued, with four of them assessing that the currency 
is priced at least 15 percent below its appropriate market 
rate.  Merrill Lynch's T.J. Bond cautioned that given the 
technical challenges involved, the pace of currency reform in 
China in unlikely to satisfy "any simple political argument." 
 Citibank's Yiping Huang echoed Bond, laying out the need to 
coordinate broader capital account liberalization with 
movement on the exchange rate.  HSBC's Hongbin Qu said that 
given these constraints, it is important to watch out for 
excessive political pressure that sets back reform.  BNP 
Paribas' Andrew Freris encouraged Graham to always leave 
China with flexibility by not making excessively detailed 
demands that, for example, include both dates and percentage 
targets with regard to RMB appreciation.  Goldman Sachs' Hong 
Liang said external pressure is a good thing but added that 
the selling point should be China's own interests. 
 
¶10. (C) CSFB's Dong Tao suggested that one possible way to 
begin closing the trade deficit would be to ease up on visa 
restrictions.  He noted that many other countries are now 
benefiting from growing Chinese tourism, not to mention the 
extensive purchases that these travelers make while 
traveling.  Goldman Sachs' Liang seconded this view, 
commenting that the Chinese elites who wish to travel to the 
U.S. are not an immigration threat.  (Note: Neither analyst 
acknowledged DHS Secretary Chertoff's recent comments to 
media that China is refusing to take back an estimated 39,000 
citizens that have been found ineligible and deportable.  End 
Note) 
 
REVIEW OF PORT SCREENING TECHNOLOGY 
----------------------------------- 
 
¶11. (SBU) The Senators visited Hong Kong International 
Terminals (HIT, part of the Hutchison Conglomerate) to see a 
demonstration of the Integrated Container Inspection System 
(ICIS), which has been set up as a pilot test here in Hong 
Kong by the U.S. firm Science Application International 
Corporation (SAIC).  SAIC is awaiting a decision from the HKG 
on whether to buy ICIS.  The U.S. Department of Energy has 
been working with the HKG on identifying options for 
extending the Megaports radiological screening program to 
Hong Kong by leveraging the capabilities of ICIS. 
 
¶12. (SBU) Hutchison Port Holdings Senior Vice President Gary 
Gilbert showed the Senators how the ICIS system generates an 
"electronic folder" for each container as it enters the 
terminal yard.  Trucks drive by scanning equipment that 
creates both an image of the container's interior and a 
radiation profile.  Were the system fully deployed, the 
electronic folder could be made available to USG personnel at 
the destination port of entry, allowing the to prioritize 
issues involving ship arrivals and follow-on inspections. 
 
¶13. (SBU) Gilbert emphasized the need for rapid scanning 
systems like ICIS, commenting that more goods are actually on 
the high seas at any given time than in transit at ports 
themselves.  Consequently, any disruption -- from instituting 
screening procedures that slow down the movement of goods 
through ports to work stoppages - very quickly causes 
bottlenecks.  80 percent ofthe world's cargo volume is now 
handled at some oint by firms from Hong Kong, Singapore, 
Dubai, r Denmark as a result of consolidation in the port 
 
HONG KONG 00001285  004 OF 004 
 
 
operator industry.  Any U.S. port security strategy must 
therefore take into account the need to work with firms from 
these locations, said Gilbert.  Hutchison facilities alone 
handle 45 percent of all U.S. cargo at some point before 
entry into the U.S. 
 
¶14. (SBU) The Senators were then briefed by the ConGen's 
Container Security Initiative (CSI) Team Leader.  CSI has 
been in operation in Hong Kong since May 2003.  The 11 
American personnel assigned here for CSI review all shipping 
manifests.  They work with Hong Kong Customs inspectors 
dedicated to supporting the screening of containers for 
weapons of mass destruction.  No WMD have been found to date 
but there has been the seizure of several million dollars 
worth of counterfeit merchandise as a result of CSI 
operations here. 
 
BUSINESS LEADERS: ANXIOUS ABOUT INSTABILITY 
------------------------------------------- 
 
¶15. (C) Participants used a dinner hosted by the BHKF to 
express anxiety about the potential for serious instability 
in China that could block the momentum of reform should 
economic and political liberalization move too quickly.  Hang 
Lung Group Chairman Ronnie Chan said that a rapid currency 
appreciation could cause unrest given that China now is a 
place where "voices are loud" but that still lacks rule of 
law to address complaints.  BHKF Executive Director George 
Yuen spoke of "priorities and varieties," explaining that the 
leadership in Beijing must constantly juggle what it wants to 
accomplish through reform with the variety of constituencies 
that are affected (e.g., different geographical areas, 
sectors, income rates, ethnic backgrounds).  Commerce, 
Industry, and Technology Bureau Deputy Secretary Philip Yung 
observed that Hong Kong developed economically before it 
liberalized politically.  Esquel Group CEO Marjorie Yang, 
noting corruption in China, questioned the capacity and 
sincerity of local government officials in deploying funds 
from Beijing aimed at improving the welfare of rural 
residents.  Yang also asserted that Internet controls 
notwithstanding, the surge effect of chatter created by 
blogging means that word spreads quickly when events such as 
land seizures or disturbances occur. 
 
IRI: IT'S NOT EASY TO BE AN NGO IN CHINA 
---------------------------------------- 
 
¶16. (C) IRI Resident Representative Amy Gadsden told Senator 
Graham that all NGOs receive extensive scrutiny in China; she 
couldn't even pull her down her own email during her trip 
there last week.  That said, IRI has a good record on the 
mainland; its proposals on extending land tenure rights were 
actually adopted by the government.  While the Internet may 
offer some outlet for debate, there remains widespread fear 
that anything posted might someday lead to a "knock on the 
door."  Gadsden said it is distressing to see President Hu 
Jintao be so hesitant about political reform.  She noted 
instances where lawyers have been detained or harassed for 
taking on sensitive cases, especially those involving Falun 
Gong. 
 
¶17. (U) Codel Graham provided a substantive clearance for 
this message. 
Cunningham