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TAGS: EFIN ECON EINV PREL PGOV CH
SUBJECT:  CODEL HAGEL:  CHINESE THOUGHTS ON WORLD FINANCIAL 
CRISIS 
 
Reftel: 1) 08 Beijing 03857 2) Paulson-Wang Qishan telcon 
Oct 11, 2008 
 
(U) THIS MESSAGE IS SENSITIVE BUT UNCLASSIFIED. PLEASE 
HANDLE ACCORDINGLY. NOT FOR INTERNET DISTRIBUTION 
 
¶1.  (SBU) Summary:  On October 13-14, Senator Charles Hagel 
met Chinese Vice Premier Wang Qishan, Central Bank Governor 
Zhou Xiaochuan, and Commerce Vice Minister Ma Xiuhong. The 
Vice Premier discussed weaknesses in the U.S. system that 
had led to the financial crisis, and asserted China's 
commitment to cooperate with the United States to resolve 
the situation, including continuing to buy U.S. debt. 
Regarding a U.S.-raised G-20 summit idea, Wang noted that 
the meeting had failed to materialize despite an agreement 
to attend on China's part, but saw the Chinese quick 
response to the offer as a positive sign.  Wang expressed 
hope that the incoming Administration would move quickly to 
clarify their China policies, noting that bilateral 
meetings such as the Strategic Economic Dialogue (SED) had 
increased confidence.  Although China and the United States 
would disagree on some issues, and arms sales to Taiwan 
were regrettable, Wang anticipated continuing the 
constructive relationship.  Governor Zhou and Vice Minister 
Ma likewise both noted opportunities for cooperation to 
stabilize financial markets, including a Chinese focus on 
growing their economy.  They saw opportunities for China to 
continue to reform its economy.  End summary. 
 
ang Qishan: Cause of Crisis 
---------------------------- 
 
¶2. (SBU) Vice Premier Wang Qishan outlined what were in his 
view the major contributing factors in the U.S. financial 
crisis: 1) a lifestyle of low savings and high consumption; 
2) excessively loose monetary policy and liquidity creation 
in response to the bursting of the Internet stock bubble 
and September 11; 3) excessive financial innovation 
combined with insufficient regulation and supervision, with 
financial assets priced on complex models that even bank 
CEOs did not understand; and 4) weak internal risk 
management, including excessive leverage of financial firms 
and executive compensation arrangements that paid large 
bonuses for strategies that led to large losses. 
 
¶3. (SBU) Wang said the proliferation of poorly understood 
financial derivatives had greatly increased financial 
leverage in the system.  The volume of credit default swaps 
is 62 trillion dollars, far outstripping any basis in the 
real economy.  The bursting of the housing bubble had led 
to a rapid shift from excess liquidity to a liquidity 
crisis, threatening a collapse of the entire global credit 
system and affecting the real economy. 
 
Commitment to Cooperate 
----------------------- 
 
¶4. (SBU) Wang said the Chinese government is very "sober- 
minded" in facing the crisis.  Although the problems 
started in the United States, the crisis affects the whole 
world and China is greatly impacted by what happens on Wall 
Street.  Wang estimated that Chinese holdings of U.S. 
Treasury securities, U.S. agency debt, and corporate stocks 
totaled USD 1.2 -1.3 trillion. 
 
¶5. (SBU) Wang supported the USG policy responses to date 
and is committed to continue cooperation.  He noted that 
the People's Bank of China (PBOC) issued a strong statement 
of support at the financial markets' most difficult moments, 
adding that last week China appeared more confident about 
the prospects for passage of a financial rescue passage 
than most Americans.  China will also contribute to the 
global economy by keeping its own growth strong, which is 
why the Chinese monetary policy was loosened last week.  He 
said that China would implement a range of policies to keep 
 
BEIJING 00003949  002 OF 004 
 
 
domestic demand growth steady, as he expects 2009 will be a 
"most difficult" year for demand in China's major trading 
partners and thus for China's economy. 
 
¶6. (SBU) Wang stressed that China is cooperating in deeds, 
not just words.  China has not sold its holdings of U.S. 
agency debt.  In response to USG requests, Wang said China 
recently bought new U.S. agency bonds. (Note: According to 
officials of the State Administration of Foreign Exchange, 
they have maintained their overall holdings of U.S. agency 
bonds, although they have switch their Fannie Mae and 
Freddie Mac holdings from long-term to short-term bonds. 
End Note.)  In his view, Senator Hagel said the U.S.-China 
bilateral relationship is as important as any in dealing 
with the financial crisis.  He said China can rest assured 
that the Congress will support the Federal Reserve, the 
Treasury, and the next President to stabilize the financial 
system, noting the United States will not fail to rise to 
the challenge of ensuring a prosperous economy.  He noted 
that the United States will inject fresh capital into 
financial institutions and stand behind the obligations of 
Fannie Mae and Freddie Mac. 
 
Summit Response 
--------------- 
 
¶7. (SBU) Wang noted that China's quick positive response to 
the U.S request that President Hu attend a leaders' summit 
on October 18 was "unprecedented" and demonstrated China's 
preparedness to be a responsible member of the global 
community (see ref telcon.)  The request was received on 
October 10 and by October 12 China had confirmed that 
President Hu would attend.  The MFA and the Embassy in 
Washington had already made considerable preparations, 
including booking hotel reservations.  However, Wang said 
he had heard earlier in the day from U.S. officials that 
due to internal G-7 divisions, the October 18 leaders' 
meeting is cancelled.  He noted how the U.S.-China 
relationship had changed: in the past, the United States 
would decide whether to have a multilateral meeting and 
then informed China, while now it reached out to China in 
advance of a decision. 
 
Hopes for New Administration 
---------------------------- 
 
¶8. (SBU) Wang noted that while past Administrations have 
taken 1-2 years to clarify their China policies, he 
expected the next Administration would move much more 
quickly.  He stressed that China needs a constructive and 
cooperative relationship with the United States for China 
to have a "peaceful" external environment so its can 
achieve its development goals.  Globalization is an 
unstoppable force, he stated, and the U.S. and China's 
interests are inextricably intertwined. 
 
¶9. (SBU) Senator Hagel agreed that the next President will 
not have the luxury of time to put his policies in place 
and would have to act quickly to map out their strategy for 
solving the financial crisis.  He said that both Senators 
Obama and McCain understand the fundamental relationship 
between the United States and China, stressing that the two 
countries are intertwined and a "divorce" is not possible. 
 
Larger Relationship, SED, and Taiwan 
------------------------------------ 
 
¶10. (SBU) Wang noted appreciation for the collaborative 
approach to bilateral relations established under the 
Strategic Economic Dialogue (SED) and highlighted that the 
SED had laid the groundwork for senior officials to be able 
to communicate daily.  Through the SED and the Joint 
 
BEIJING 00003949  003 OF 004 
 
 
Commission of Commerce and Trade (JCCT), issues important 
to either side are on the table for discussion, including 
IPR, investment, energy and the environment, high- 
technology trade, food and product safety, and agricultural 
trade. 
 
¶11. (SBU) On the broader U.S.-China relationship, Wang said 
there was no difference on fundamental interests.  In his 
view the main disagreements were over the "internal 
sovereign issues" of Tibet, Taiwan, and Xinjiang.   Wang 
appreciated U.S. support for the Beijing Olympics, and said 
the President's visit at a time of financial stress in the 
United States was warmly received.  However, he expressed 
concern about the recent arms sale to Taiwan.  In Wang's 
view, the weapons were less of a concern than the signal 
the sale provides that will embolden supporters of Taiwan 
independence.   He noted the timing was regrettable as 
U.S.-China relations had improved after Chen Shui-bian's 
election loss  Nevertheless, Wang said China would continue 
to cooperate with the United States on  coordinated 
responses to the financial crisis.  Senator Hagel agreed 
that, while the U.S. and China will continue to have 
differences, these differences should not be allowed to 
frame the relationship. 
 
Central Bank:  Chinese Response to Situation 
-------------------------------------------- 
 
¶12. (SBU) At his meeting with Senator Hagel, PBOC Governor 
Zhou Xiaochuan noted that China is following the U.S. 
financial turmoil closely, both because Chinese economic 
and financial markets are now integrated into global 
markets, and because China is a major investor in U.S. 
Treasuries and government agency securities.  Noting that 
he did not speak for the Congress or any Administration, 
Senator Hagel sought to reassure Governor Zhou that Fannie 
Mae and Freddie Mac might emerge in a few years with 
different structures, but the U.S. government would stand 
behind the organizations.  Zhou hailed the major central 
banks' coordinated action to "rescue" the financial system. 
 
¶13. (SBU) Governor Zhou noted that he would see Secretary 
of Treasury Paulson and Federal Reserve Chairman Bernanke 
this weekend.  (Note: This was an apparent reference to the 
suggested summit referenced by Wang Qishan. End note.) 
 
¶14. (SBU) Zhou said the Chinese Government and the PBOC are 
prepared to do whatever is necessary to assist in 
stabilizing markets, including injecting liquidity into the 
Chinese market.  The Chinese financial markets, however, 
are still "not sophisticated" and capital income is low, so 
China is not as affected by the unrest in the global 
financial markets. 
 
¶15. (SBU) Moving forward, Zhou said that the Government's 
economic goals had shifted suddenly from "controlling 
inflation" to providing a "flexible and prudent" response 
to the global situation.  Following the Third Party Plenum 
this weekend (see reftel), the PBOC was now hard at work 
developing a "probably temporary" response package.  (Note: 
At the Politburo-level meeting that ended on Monday, 
leaders had been expected to discuss appropriate fiscal and 
monetary measures to respond to tighter global credit 
conditions and falling demand in China's major export 
markets.  End note.) 
 
Macro and Rural Reform 
----------------------- 
 
¶16. (SBU) Turning to rural reform, the official focus of 
the Plenum, Zhou noted that, because China needs to control 
migrant labor, the land reform process must be orderly.  He 
 
BEIJING 00003949  004 OF 004 
 
 
thought that the size of farms would remain small, but 
farmers would be allowed to diversify their activities to 
maximize production.  (Embassy comment: Observers had 
expected that the Plenum to move forward on land reform, 
allowing farmers to transfer and consolidate land to 
improve productivity and yields.  Some social critics had 
worried that this would create a class of landless peasants 
if the economy slowed.  Zhou's comments may indicate that 
concerns over migrant labor may have tempered enthusiasm 
for sweeping land reform at the Plenum.  End comment.) 
 
¶17. (SBU) He said the government for the past five years 
has encouraged farmers entering the work force to move into 
non-export dependent industries.  This was part of an 
effort to transition China from an export-led to a domestic 
consumption-led economy.  The Chinese people, however, due 
their long experience with shortages, tended to have high 
consumption rates.  That said, retail sales growth was 
strong, and service sector demand was gradually increasing. 
 
Commerce Ministry: Collaboration, not Protectionism 
--------------------------------------------- ------ 
 
¶18. (SBU) Commerce Vice Minister Ma said China fully 
understands the gravity of the financial crisis.  She said 
China first will continue to work with other major 
economies to cooperate in solving the financial crisis. 
Second, China would continue to reform and open its economy, 
and oppose protectionist measures and sentiments. 
According to Ma, China has had great success in increasing 
U.S. exports to China, and increased Chinese demand will 
create opportunities for U.S. exporters.  Increased Chinese 
demand for nuclear and clean energy technologies also 
creates opportunities for U.S. technology exports.  Third, 
as world demand slows, China will stabilize its own growth 
through stimulating domestic consumption, including through 
the implementation of measures delineated at the Third 
Plenum of the 17th Party Congress.  Maintaining China's 
internal economic stability in itself contributes to global 
stability. 
 
¶19. (SBU) Both sides discussed the importance of 
international cooperation in addressing the financial 
crisis, and emphasized the common interest in opposing 
increased protectionist sentiment.  Vice Minister Ma noted 
that changes in U.S. presidential administrations present 
challenges in our bilateral relations. 
 
¶20. (U) THIS CABLE HAS BEEN CLEARED BY THE DELEGATION.