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FUTURES
MARKETS FOR CHINA
China
Council for the Promotion of International Trade (CCPIT)
September 2004
Beijing, China
We
stand at the dawn of the Twenty First Century. Admittedly, the
geopolitical landscape is laden with terrible strife, controversy
and danger. Similarly, there exists the specter of economic difficulties
within many regions of the world. Nevertheless, the Twenty First
Century represents unlimited opportunities and that is especially
true for China and East Asia.
Today,
nearly every country on the planet has a market-oriented economic
system and is attempting to be a competitor in the global marketplace.
For the past 20 years when we spoke of a global economy, we were
talking about only 25% of mankind—mostly
North America, Western Europe, and Japan. Suddenly, there are
three billion more participants in the global economic system.
For
centuries China stood as a leading civilization in culture and
science. Then came the political upheavals and internal problems
of the 19th and early 20th centuries that
brought a virtual halt to its history of progress. However, in
1978, the new government under Deng Xiaoping introduced market
reforms with an eye toward a market economy. The result: China
again became the world’s growth leader with an output that quadrupled
in the last two decades.
Thus,
China is making the transformation from a communist centrally-planned
economy into what authors John Wong & Lu Ding of the National
University of Singapore, call a "socialist market economy," which
increasingly embraces free markets principles. As they point
out, within a few short years it became the workshop of the world.
I want to take this opportunity on behalf of the Chicago Mercantile
Exchange to publicly congratulate President Hu Jintao and wish
him luck in continuing the path on which China is successfully
pursuing. The rapid growth has strengthened China’s economic
power and begun the process of raising the standard of living
for its people. Make it in China and export it back to the rest
of the world is now a predominant business strategy. Foreign-affiliated
companies now account for half of China’s exports of manufactured
goods. Indeed, direct foreign investment into China has become
the world’s major trend, putting America in second place for
the first time. That is a dramatic metamorphosis.
However,
continued growth will not be without pain. China’s markets are
still a long way from embracing all the tenants of the free market.
Major structural problems remain. Learning how to maximize the
benefits of globalization, while minimizing internal disruptions
will be a formidable challenge for policy makers. As China embraces
the World Trade Organization and becomes integrated into the
world economy, it urgently needs to improve the domestic business
environment and to strengthen indigenous industries. While Chinese
companies are entrepreneurial, flexible and focused on profitability,
they need the financial tools to manage capital more efficiently.
Today,
the largest difference between rich and poor countries—between
economic hope and economic despair for its people—is the freedom
and efficiency with which they can utilize their resources. Free
and efficient capital markets ensure that resources are allocated
wisely. The more efficient the system, the better the allocation
of these resources. Efficient markets lead to greater market
liquidity. A liquid market reflects truer price values and gives
investors confidence in the marketplace. As a consequence, capital
markets are strengthened, capital cost is reduced, and capital
is utilized more efficiently. Ultimately, the standard of living
is enhanced, and social order is greatly benefitted.
To
manage modern financial risks, the marketplace has turned to
financial derivatives. The economic function of these instruments
is to provide a safety-net based on benchmark groupings of inherent
business exposures or to unbundle the risks involved into their
basic components and transfer them to those most able and willing
to assume and manage each component. Consequently, financial
derivatives—both on centralized futures and options exchanges
or customized in the OTC market—can be likened to a gigantic
insurance company that allows financial market risks to be adjusted
quickly, more precisely, and at lower cost than is possible with
any other financial procedure. It’s a process that has strengthened
capital markets and improved national productively growth and
standards of living.
Nobel
Laureate, Merton Miller, once stated that the simple standard
for judging whether a product increases social welfare is whether
people were willing to pay their hard earned money for it. In
other words, is the product being used. By that standard, financial
futures products proved their worth a billion times over. They
motivated the concept of financial engineering, engendered the
era of OTC derivatives, and spawned financial futures exchanges
in every corner of the globe—from Argentina to Australia, from
Italy to India, from London to Kuala Lumpur and propelled the
CME into first place in the world. Today, according to the BIS,
outstanding notional value of Over the Counter derivatives as
of December 2003 reached $197 trillion. Add to that the current
value of open interest on centralized exchanges and you approach
an outstanding notional total of approximately $240 trillion.
The
reasons for this phenomenal growth, especially during recent
years is clear: The world has increasingly become but a single
global market—a market within which information travels at Internet
speed, within which competition is intense, where interest rates,
exchange rates, and other asset values are volatile, and where
dangers as well as opportunities, global, regional, or local,
rapidly appear and disappear on an ever changing financial horizon.
We
note that financial futures were developed at the CME in the
wake of the breakdown of the Bretton Woods and its system of
pegged exchange rates. Our market was an important factor in
advancing the development of global markets. Which brings to
mind the current discussion over a possible revaluation of the
Chinese Renminbi. We are sympathetic to the fact that currency
controls, capital controls, and export subsidies often serve
a purpose during the formative stages in an emerging economy—but
at some point, the economy must throw off such shackles in order
to avoid impeding further development. That point is now. Accordingly,
we urge the development of a financial derivatives market here
that can assist in managing the risks attendant to an emerging
and blossoming financial ecosystem. More to the point: The Chicago
Mercantile Exchange stands ready to assist this process.
We
applaud the National People’s Congress acknowledgment for the
need for additional futures instruments. Under the direction
of the China Securities Regulatory Commission there is now a
reformed market structure with several important futures markets.
These actions have given much needed encouragement to the growth
of a modern futures market in China. It propelled the Chicago
Mercantile Exchange, the largest futures market in the US, to
execute an historic Memorandum of Understanding with the Shanghai
Futures Exchange as well as with China Foreign Exchange Trade
System (CFETS). These agreements will allow the CME to provide
expertise and advice to their Chinese counterparts with a goal
to ultimately create mechanisms for viable derivative markets
in China.
It
cannot be over-emphasized: Transformation in information technology
created a world economy. Current political confrontations notwithstanding,
it will continue to foster more globalization, greater interdependence,
instantaneous informational flows, immediate recognition of financial
risks and opportunities, continuous access to markets of choice,
more sophisticated techniques, new innovations, and intensified
competition. These are the unalterable trends of the Twenty First
Century. The markets of China must embrace this paradigm.
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