5. Im­pli­ca­tions and Pol­icy Rec­om­men­da­tions for China

China Economist - - Articles -

long-term bonds by three notches and Moody and Fitch also down­graded AIG by two notches. By the new rat­ing and share price, AIG must pay an ad­di­tional mar­gin of US$ 32 bil­lion within 15 days to guar­an­tee the safety of its de­riv­a­tives con­tracts worth US$2 tril­lion. To avoid the chain re­ac­tions caused by the de­fault of de­riv­a­tives con­tracts, AIG held emer­gency con­sul­ta­tions with the New York Fed­eral Re­serve Bank and rat­ings agen­cies that led to a fi­nal agree­ment on Septem­ber 22 to ac­quire a loan of US$ 37 bil­lion from the Fed­eral Re­serve to avoid its bank­ruptcy10 Un­der the neg­a­tive • in­for­ma­tion, de­riv­a­tives trad­ing brought both in­ter­na­tional in­sur­ance com­pa­nies and the Fed­eral Re­serve into jeop­ardy.

US fi­nan­cial in­sti­tu­tions pos­sessed tremen­dous fi­nan­cial de­riv­a­tives con­tracts be­fore and af­ter the cri­sis. By the end of 2015, the nom­i­nal value of de­riv­a­tives con­tracts held by Bank of Amer­ica amounted to US$ 42.2 tril­lion, and Citibank held de­riv­a­tives con­tracts worth US$34.99 tril­lion. With a small amount of mar­gin, US fi­nan­cial in­sti­tu­tions pos­sessed tremen­dous ini­tial de­riv­a­tives con­tracts to en­gage in de­riv­a­tives trad­ing with 50 times lever­age. They not only con­trol in­ter­est rates, ex­change rates and share prices in a cer­tain fu­ture pe­riod but con­trol the fu­ture prices of oil, me­tals and ores on the com­mod­ity fu­tures mar­kets, turn­ing them into in­stru­ments to lock up mar­ket prices and seek wind­fall prof­its. The real con­troller of the en­tire de­riv­a­tives mar­ket now ap­pears to be the Fed­eral Re­serve. In de­riv­a­tives con­tracts with a no­tional value of US$ 30- 50 tril­lion ( with an­nual vari­a­tions) dis­closed by Citibank dur­ing 2007-2015, 75% d were m. ter­est rate swaps 11 an m. ter­est rate volatil­ity was con­trolled by the Fed­eral Re­serve. Af­ter leav­ing the US Fed­eral Re­serve, Ben Ber­nanke be­came a se­nior ad­viser to Ci­da­tel, which is one of the big four hedge funds and the only fund com­pany in the United States that can en­gage in hedge fund trans­ac­tions as mar­ket maker to im­ple­ment the US global fi­nan­cial strat­egy. This strat­egy now ap­pears to have con­tin­u­ously pushed up the US stock mar­ket, at­tract­ing in­ter­na­tional float­ing cap­i­tal to fuel the US econ­omy. By ma­nip­u­lat­ing the price volatil­ity of in­ter­na­tional bulk com­modi­ties and cre­at­ing pres­sures on the cur­ren­cies of emerg­ing economies, this strat­egy sent emerg­ing econ­omy gov­ern­ments into pas­sive and un­fa­vor­able po­si­tions.

Af­ter three decades of devel­op­ment, de­riv­a­tives trad­ing turned the U. S. into an eco­nomic casino and global fi­nan­cial mar­kets into a fi­nan­cial casino de­spite re­sis­tance by France and Ger­many. Af­ter the storms of the global fi­nan­cial cri­sis, this fi­nan­cial casino is once again tamed by the Fed­eral Re­serve and turned into a fi­nan­cial "weapon of mass de­struc­tion" against other coun­tries and re­gions. As War­ren Buf­fett put it in 2008, no one is will­ing to prof­i­teer from sell­ing short on his own coun­try. But sell­ing short on other coun­tries is quite fre­quent. The roller­coaster volatil­ity of China's stock, bond and fu­tures mar­kets alarmed the Chi­nese pub­lic about the gam­bling na­ture of fi­nan­cial mar­kets. How­ever, Chi­nese author­i­ties ex­pect to cre­ate a well­func­tion­ing fi­nan­cial mar­ket ( in­clud­ing a de­riv­a­tives mar­ket) to en­sure a cer­tain de­gree of pric­ing power for China in the in­ter­na­tional fi­nan­cial mar­ket.

Judg­ing by the cur­rent sit­u­a­tion, how­ever, not only is this ex­pec­ta­tion likely to fall short but China may pay a heavy price in an asym­met­ric fi­nan­cial war as well. In­deed, the US govern­ment does not wield dom­i­nant con­trol over its econ­omy, which is over-re­liant on fi­nan­cial mar­kets and lacks mo­men­tum of growth. Yet in­stead of re­peat­ing the boom-bust cy­cle as had been pre­vi­ously the case, the US econ­omy is now able to trans­fer its do­mes­tic 1° For a de­tailed ac­count of the process, please re­fer to AIG An­nual Re­port 2008, Form10-K, pages 1-2. u See Citibank's an­nual re­ports 2007-2015 (de­riv­a­tive na­tion­als page).

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