For two decades now, since the Tiananmen Square massacre, Western political leaders have been putting on a half-hearted show of being seen to be trying to impose on China the Western values on human rights. Half-hearted, because, as everyone knows, trade and manufacturing deals with China took precedence. Money talked, and China did not change its values.

Now, a recently released Wiki-leaked U.S. embassy cable from Beijing, dated 20th March 2009 – at the height of the second wave of panic that followed in the wake of the Lehman collapse – hints that the flow of values was, if anything, going in the opposite direction: whatever other intentions Western governments may have had in dealing with their insolvent banking systems, the leaked embassy cable reveals that ‘communist’ China made it very clear to the representatives of ‘capitalist’ USA that losses for senior bank creditors was not going to be an option, as far as China was concerned. Money talked, and the West’s subsequent actions were ultimately not inconsistent with the Chinese belief on forced economic outcomes regardless of the distortionary costs.

In what follows, I will quote from the WikiLeaks cable:




E.O. 12958: DECL: 03/20/2034


Classified By: Economic Minister Counselor Robert Luke; Reasons 1.4 (b,d)

1. (C) Since Premier Wen Jiabao’s March 13 remarks at a press conference that China was “concerned” regarding the security
of its U.S. Treasury holdings and other investments
other Chinese contacts have clarified and interpreted his comments. At the G-20 ministerial meeting in London, the head of the State Administration of Foreign Exchange (SAFE) and Deputy Central Bank Governor noted continued Chinese concerns about the inflationary implications of the expansion of the Fed’s balance sheet. In a meeting that preceded Wen’s remarks, SAFE Director General (DG) Yin Yong noted SAFE’s concerns about the potential for U.S. dollar depreciation and U.S. inflation, as both would erode the renminbi (RMB) value of their assets. On March 19, DG Yin told us that Premier Wen and other senior leaders believe it is important to avoid actions that could be perceived as adversely impacting the claims of senior creditors to systemically large financial institutions and to avoid a repeat of “(the) Lehman (situation)” in 2008. MOF Assistant Minister Zhu Guangyao said that enhancing confidence and trust should be an important theme of the next Economic Dialogue. Other Chinese contacts have offered similar versions of their Government’s concerns, with one noting that there has been a “huge debate” within the government about China’s holdings of U.S. Treasuries. See comments in paragraphs 8-10. End Summary.

2. (U) At the March 13 closing press conference of the National People’s Congress (NPC) in Beijing, Premier Wen Jiabao was asked about U.S. measures to counteract the global financial crisis in light of China’s large holdings of U.S. debt, and also about China’s strategy to spread investment risk if the USD depreciated. In response, Wen said China was “paying close attention” to the U.S. economic situation and the USG’s measures to address the crisis. He then added that “we are certainly concerned about the security of our assets” and “I am a little concerned.” Following the press
conference, coverage of Wen’s remarks by China’s official Xinhua news agency acknowledged the Premier’s “worries” while also reporting that Wen expected U.S. measures would “counter” the crisis. Xinhua also noted that China’s reserves were “generally safe” (ref).

What Did Wen Mean?
3. (C) Wen’s remarks immediately generated intense speculation that China might be contemplating some adjustment in its foreign reserve management policy. Shortly after reports of the Premier’s remarks became public, U.S. Treasury Department Acting Assistant Secretary Sobel raised the issue with State Administration of Foreign Exchange (SAFE) Director (and People’s Bank of China Deputy Governor) Hu Xiaolian. (Note: SAFE is the Chinese government agency responsible for managing China’s reserves.) In response, Hu noted China’s continued concerns about the inflationary implications of the expansion of the Fed’s balance sheet; her comments closely paralleled those conveyed by SAFE Director General (DG) for Reserve Management Yin Yong during a February 26 meeting in Beijing with visiting U.S. Treasury DAS Dohner. On that occasion, Yin had observed that SAFE was concerned about the
risks of U.S. dollar depreciation and U.S. inflation, as both would erode the RMB value of their U.S. dollar denominated assets. Yin called President Obama’s announced intention to cut the federal budget deficit by the end of his first term a wise step, and said he would like to see measures by the Federal Reserve to unwind its injection of liquidity after the financial crisis ends.

Stabilize the Economy, and Protect the Investors
——————————————— —
4. (C) In a March 19 follow-up conversation with Finatt, SAFE DG Yin, who clearly had deferred meeting with us until he received approval and guidance from his superiors, said the Premier had been “worrying” about all of China’s investments in the U.S., including U.S. Treasury securities. Wen also had “noticed” the policies promulgated by the administration of President Obama, and hoped that the measures taken to address the global economic crisis would help to stabilize the financial systems and promote economic recovery. Yin also said his “understanding” of Premier Wen’s message was, in addition to the above objectives, that U.S. policy should focus on protecting the interests of investors, as both financial stability and protecting investor rights were important for strengthening the confidence of domestic and foreign investors.

5. (C) Continuing, DG Yin said he believed the USG measures taken thus far are “responsible” and he hoped any future interventions in systemically large financial institutions also would be responsible and consistent. Ensuring that would be vital for maintaining investor confidence, while anything harmful to confidence would also undermine financial stability. Yin noted concern about “voices” in the U.S. — but not in the Obama Administration – that were recommending “sacrificing” the interests of some senior creditors’ claims on systemically large financial institutions. (Comment: Some U.S. commentators have suggested that the U.S. government require that senior creditors take “haircuts” as a condition for intervening in U.S. financial institutions. In previous
cases where the FDIC took over insolvent banks, not all creditor claims were honored in full). After Finatt observed that USG interventions taken to date in large financial institutions have for the most part been designed to maintain the confidence of holders of senior debt, Yin replied that U.S. policies should be consistent, “not like Lehman” in 2008. (Comment: Several interlocutors have told us that Lehman was a counterparty to SAFE in financial transactions and as a result SAFE suffered large losses when Lehman collapsed.)


7. (C) On March 18 Director Xiao Lian of the Center for American Economic Studies at the Chinese Academy of Social Sciences (CASS), told us that Premier Wen and the senior leadership have been under “strong pressure” to address public criticism about recent high profile losses on China’s overseas investments. Xiao also speculated that Wen may have wanted to reiterate China’s concerns, perhaps more clearly understood by former Secretary Paulson and other now-departed U.S. officials, to the new Obama administration. On March 16, CASS researcher Zhang Ming speculated to us that China may want to invest in Treasury Inflation-Protected Securities (TIPS) or RMB-denominated assets, to protect its overseas investments. Professor Yu Yongding, also of CASS and Director Xiao Lian’s superior, has long advocated that China press the U.S. to issue RMB-denominated debt, and at a recent conference Yu opined that China should receive equities in U.S. nationalized banks as collateral for its U.S. investments. Xiao told us he has proposed that the U.S. Government issue convertible bonds that Chinese investors could convert into stocks (presumably of financial institutions held by the U.S. government).


Last fall on numerous occasions, Vice Premier Wang Qishan remarked to then-Secretary Paulson, both privately and during the public session of the Strategic Economic Dialogue, on the need to “protect” Chinese investments.


10. (C) We believe Wen’s remarks were most likely intended to acknowledge rising public criticism over the government’s losses on its investment of reserves (fueled by high-profile losses by the China Investment Corporation (CIC) in Blackstone and Morgan Stanley). Wen also probably intended to maintain blame for China’s current cyclical downturn on foreign factors, urge the U.S. and others to act resolutely to restore financial stability and to stem the decline in financial assets; signal to western governments that when intervening in financial institutions not to trample on the claims of foreign investors (e.g., as was done to China’s Ping An insurance company with its investment in Belgium’s Fortis); and, avoid surprises that could adversely impact the claims of senior creditors. Ironically, one of the largest USG interventions in financial institutions to date was in Freddie Mac and Fannie Mae, where it agreed to inject up to USD 400 billion in capital to keep the institutions solvent. As former Secretary Paulson noted, this “effectively guarantees” claims of senior creditors, the largest of which is most likely SAFE.


China’s ruling elite has a value system for economic development centred around top-down goal setting, and bottom-up delivery of expected results which also feed into the primary goal – the overall growth requirement essential for the political legitimacy of the elite. This is not a system which has room for “taking your medicine”, as opposed to the system of Western economies with (formerly?) independent Central Banks which could and did impose recessions and bank restructuring (see resolution of S&L crisis in US in 1980’s) to prune dead weight and renew the underlying strength of their economies.

The references in the leaked cable to Paulson’s “understandings” with China hints that the fall 2008 U.S. bailouts may have been insidiously presented by him to an awe-struck Congress as an urgent necessity following a Chinese ultimatum when in reality, most likely, Paulson had at the back of his mind the life-or-death situation facing his former company, Goldman Sachs.

Seen from this perspective, China’s money has talked, and the Chinese elites’ values of subverting market outcomes for an ulterior motive found fertile and willing ground in the hearts and minds of their counterparty elites that actually run the US from behind the scenes. These elite value systems have subsequently constrained OECD policymakers from reforming their insolvent banking systems properly according to the traditional Western value system, haircuts and all. China’s money has talked, and its values easily took root in Western government policy.

It will be interesting to watch related developments in Europe over the next few months and years, as the pressure on the European banking system intensifies. Will China try to resist the haircuts that Angela Merkel has committed herself to? If China opposes Eurozone haircuts and tries to bring pressure to bear, will European leaders have the moral and political fortitude to call China’s bluff and impose the haircuts anyway?