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UNCLAS SECTION 01 OF 04 SHANGHAI 000372 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EAP/CM 
NSC FOR LOI/MEDEIROS 
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN 
USDOC FOR ITA DAS KASOFF, MELCHER, SZYMANSKI, MAC/OCEA 
TREASURY FOR OASIA/INA -- DOHNER/WINSHIP/YANG 
TREASURY FOR SED -- LOEVINGER/OWENS/VAN HEUVELEN 
TREASURY FOR IMFP -- SOBEL/CUSHMAN 
STATE PASS CEA FOR BLOCK 
STATE PASS CFTC FOR OIA/GORLICK 
MANILA FOR ADB USED 
 
E.O. 12958: N/A 
TAGS: CH ECON EFIN EINV PGOV
SUBJECT: U.S.-CHINA STRATEGIC & ECONOMIC DIALOGUE: SHANGHAI OBSERVERS 
UNCERTAIN ABOUT FUTURE OUTCOMES 
 
¶1.  (SBU) Summary: Shanghai financial sector representatives 
generally acknowledge the symbolic and confidence-building value 
of the U.S.-China Strategic and Economic Dialogue (S&ED), 
although many are uncertain about the actual economic impact of 
the discussions.  End summary. 
 
============================================= ================== 
The S&ED Strikes the Right Tone . . . But Can It Hold the Tune? 
============================================= ================== 
 
¶2.  (SBU) Our contacts in Shanghai's financial services sector 
-- including U.S. and European banks, domestic and international 
fund managers and securities houses, and Chinese scholars -- 
confirmed that S&ED messaging crafted in the United States has 
reached the intended audience in Shanghai.  Many sources 
recognized or employed key U.S.-derived phrases such as 
"long-term, strategic engagement," or "positive, cooperative, 
and comprehensive relationship."  The overwhelming majority of 
our contacts emphasized that the Chinese attach great importance 
to the S&ED and appreciate the Obama Administration's efforts to 
set a positive tone -- one that recognizes differences between 
the two countries while striving to advance common goals.  A 
contact at the Shanghai Academy of Social Sciences (SASS), 
however, wondered how the U.S.-China relationship will shift 
once recovery is assured.  He worried that the United States 
might be more aggressive towards China after the financial 
crisis, when the United States has less of a need for Chinese 
cooperation. 
 
¶3.  (SBU) Despite initially positive feedback, some of our 
contacts expressed uncertainty about the S&ED's ability to 
convert positive sentiment into tangible outcomes in both the 
short and long terms.  For example, a vice chairman of the 
Shanghai Institutes for International Studies (SIIS) praised the 
S&ED framework for what it set out to achieve, and said he was 
satisfied by the first round of the Dialogue.  Yet, he also 
expressed fear that (i) the S&ED might just be a "talk shop", 
where nothing is actually accomplished, and (ii) that future 
meetings would digress into very specific, less strategic issues 
like its predecessor, the SED, did.  The vice chairman expressed 
concern that the S&ED might be "old wine in a new bottle" -- 
that it would not live up to its goal of addressing the most 
important long-term strategic issues facing both countries. 
 
============================================= ========== 
Concern on Market Economy Status, Safety of U.S. Assets 
============================================= ========== 
 
¶4.  (SBU) Market Economy Status (MES) was the most frequently 
raised concern when discussing S&ED outcomes.  Our Chinese 
contact at a securities house asked how China could be granted 
MES, while the vice chairman of SIIS pushed for a better sense 
of the timeline of when this could be achieved.  He described 
the failure to grant China MES as another form of protectionism 
-- like regulation of high-tech trade or restrictive U.S. import 
 
SHANGHAI 00000372  002 OF 004 
 
 
tariffs on Chinese tires -- to which China should not be 
subjected.  This contact said he was concerned about increasing 
nationalism, protectionism, and trade conflicts between the 
United States and China, as well as the role the U.S. Congress 
plays in inflaming these issues.  He advocated for educating 
domestic audiences in both the United States and China so that 
uninformed public opinion does not get in the way policy-making. 
 
¶5.  (SBU) Our contacts also raised the issue of China's role in 
international financial institutions.  Our contact at SASS asked 
how reform of international financial architecture as mentioned 
in the Economic Joint Fact Sheet issued following the S&ED would 
come to fruition, given the fact that each country is acting 
according to its own interest and not necessarily in support of 
the whole system.  He asked about what the United States will 
propose with regard to special drawing rights (SDR) and 
utilizing the renminbi as part of the SDR currency basket, 
adjusting IMF quotas, and "recognizing the demand" for moving 
away from the U.S. dollar as world's reserve currency.  He 
stated that if the United States neglects the demand for 
stability in the markets by maintaining the hegemony of the 
dollar, sooner or later it could lead to another crisis.  A few 
of our Chinese contacts sought insight into whether the United 
States will be shifting away from the G8 as the power base for 
an international economic governing body and towards the G20, 
due to the G8's "recent loss of credibility." 
 
¶6.  (SBU) Officials at the Shanghai Stock Exchange and other 
Chinese institutions stated their concern with requiring Chinese 
companies to conform to Generally Accepted Accounting Principles 
(GAPP).  According to one source, this regulation would impose a 
$10 million one-time cost on Chinese companies.  This could be 
avoided if the United States were to accept Chinese accounting 
standards. 
 
¶7.  (SBU) A few contacts stressed the safety of U.S. assets as 
their primary concern.  Our contact at SASS and a well-respected 
Shanghai-born source at a U.S. bank said some Chinese economists 
worry the U.S. Federal Reserve will not be able to absorb extra 
liquidity when the U.S. economy recovers.  Our Shanghai-born 
banking source stated his belief that the U.S. Federal Reserve 
can never de-lever its balance sheet, except at the expense of 
economic growth -- reinforcing the point that this will never 
happen, he said.  He expressed concern that inflationary 
pressure in the U.S. would spread to the world economy.  Our 
SASS contact also stated that quantitative easing should not be 
permitted, and noted the risk of inflation posed by some of the 
U.S. Federal Reserve's actions.  In contrast, other financial 
sector contacts -- both American and Chinese -- dismissed fears 
of pending inflationary pressure in the United States. 
 
¶8.  (SBU) A number of conversations also revealed Chinese 
concerns related to the United States' fiscal deficit.  The 
first question in a list of concerns raised by a general manager 
of a Shanghai securities house was "how can the United States 
 
SHANGHAI 00000372  003.2 OF 004 
 
 
guarantee the safety of U.S. assets in light of the fiscal 
deficit?"  A professor from Tongji University expressed Chinese 
worries about a possible depreciation in the value of Chinese 
investments in U.S. Treasuries. 
 
============================================= ======== 
U.S. Financial Sector Concern About Market Access and 
Implementation of Outcomes 
============================================= ======== 
 
¶9.  (SBU) For U.S. participants in Shanghai's financial services 
sector, market access for foreign banks in China remains a 
sticking point.  Many were critical of the U.S. government for 
not doing more to advance this issue.  Senior representatives 
from two U.S. banks and a third asset management fund declared 
that U.S. companies are still hindered by stringent control of 
ownership, slow licensing processes, and opaque approval 
systems.  Our U.S. contacts routinely objected to restrictions 
on ownership of joint ventures and the 20 percent ownership cap 
imposed on individual financial firms' investments in local 
banks. 
 
¶10.  (SBU) Our U.S. sources in Shanghai, while recognizing the 
positive framework of the S&ED, frequently questioned how 
agreements coming out of the S&ED would actually be implemented, 
a concern that muted their full endorsement of the dialogue. 
Three contacts at a U.S. bank stated that implementation of some 
of the previous Strategic Economic Dialogue (SED) outcomes 
remains unclear.  For example, foreign banks were approved to 
underwrite Chinese corporate bonds in December 2008, through SED 
¶V.  However, eight months later, no U.S. bank has actually 
underwritten any corporate bonds.  Several others expressed the 
view that more systematic processes and improved transparency 
are necessary to drive real progress on outcomes from the S&ED 
and also to advance Shanghai as an international financial 
center.  One contact said that without a good system, U.S. banks 
will continue to work alone, forging one-off deals with the 
Chinese government that serve to box-out other U.S. financial 
sector participants. On a more positive note, several of our 
sources noted that getting new products to market has been 
slightly easier than trying to become an underwriter, but this 
process also lacks a systemized, transparent approach. 
 
============================================= 
Fine-Tuning Market Liberalization Discussions 
============================================= 
 
¶11.  (SBU) According to a contact at Gaohua Securities 
(Goldman's JV) and our source at SASS, the S&ED I agreement to 
liberalize interest rates is not critical to Shanghai's 
development as an international financial center.  Our contacts 
argue that lending rates have been liberalized significantly. 
They explained that banks can charge different interest rates 
according to credit worthiness as long as they stay within the 
People's Bank of China's broad range of permissible rates. 
 
SHANGHAI 00000372  004 OF 004 
 
 
Additionally, the liberalization of interest rates will not 
cause a shift in capital efficiency or an increase in domestic 
consumption, the SASS source said, because interest rates are 
high as compared to the rest of the world. (Comment:  There 
remains a floor for lending rates, meaning the most creditworthy 
borrowers pay a higher interest rate than they otherwise would 
absent the controls.  In addition, the difference between 
inflation-adjusted growth and lending rates in China, averaged 
over the course of a macroeconomic cycle, remains one of the 
highest in the world, contributing to excessively 
capital-intensive growth. End comment.) 
 
¶12.  (SBU) One of our contacts explained that it is more 
important to remove the ceiling on deposit rates than the floor 
on lending rates. The ceiling (currently 2.25%) is set by the 
People's Bank of China, and no bank is allowed to give higher 
rates.  At this time, he said, even though banks have more money 
than they can lend, they still aim to increase market share. 
Yet they cannot attract deposits by increasing rates.  To get 
around this, banks can and do create different incentive 
structures and products.  For example, they might give cash 
rebates (both formal and informal) to corporate treasurers to 
attract deposits.  (Comment:  The inability of banks to compete 
on price constrains the growth of the most efficient banks. 
Furthermore, low inflation-adjusted returns on financial assets 
are one reason the growth of household income has trailed GDP 
growth, leading to a steady decline of household consumption as 
a percent of GDP.  End comment.) 
 
======= 
Comment 
======= 
 
¶13.  (SBU) The S&ED is widely recognized by our Shanghai sources 
as an opportunity for the United States and China to work 
constructively on a host of financial issues of critical 
importance.  However, our contacts are not yet convinced that 
the S&ED will be able to resolve issues of importance in a 
timely manner.  The renewed emphasis on gaining Market Economy 
Status for China reflects deep-seated worries about U.S. 
measures that could inhibit China's capacity to exploit future 
U.S. demand for Chinese-made goods as the American economy 
recovers. 
CAMP