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International Conference on

“The Establishment of the AEC and RCEP: Challenges and Opportunities”

RCEP、OBOR、AIIB and RMB:

China Challenges the Global Economic Order, and it’s Implications for Taiwan

Dr. Chung-Hsing Chen

Mega Financial Holdings

July 29, 2015

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Table of Contents

I. Introduction

II. AEC & RCEP: ASEAN’ Aspiration & Challenges

III. Challenging Int’l Economic Order: Does China Have a Mega Strategy?

IV. Why China Decided to take All These Offensives ?

V. Why Internationalizing RMB?

VI. A Conducive Global Environment for RMB

VII. Who Will Control the Money? Dollar, Euro, and RMB as Three Pillars

VIII. Conclusion and Implications for Taiwan

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I. Introduction

Who controls the food supply controls the people;

who controls the energy can control whole continents;

who controls money can control the world.

Henry Kissinger

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II. AEC and RCEP:

ASEAN’s Aspiration & Challenges

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AEC 2015 is an Ambitious Goal

ASEAN members agreed to establish an ASEAN Community by 2020 with the ASEAN Political-Security Community, the ASEAN Socio-Cultural Community, and the ASEAN Economic Community (AEC) as its pillars.

ASEAN later decided to expedite the establishment of AEC to 2015. The vision for AEC 2015 is the partial economic union of 10 ASEAN countries.

Four Main Goals of the AEC

Source: SEANET

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Progress Being Made on Tariff Reduction, …

• The reduction of tariffs on physical goods trade amongst ASEAN countries has been largely realized, with the exception of sensitive product categories like rice.

Average Tariff Reduction on Intra-ASEAN Imports

Source: SEANET

Image from: thediplomat.com Image credit: shutterstock.com

But progress on liberalizing non- tariff barriers, movements of persons and capital as well as trade in services are lagging behind, and moving rather slow.

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But More Works Need to be Done

AEC is facilitating the movement of professionals and talents.

The ASEAN Movement of Natural Persons (MNP) Agreement outlines the immigration formalities for the temporary entry or temporary stay of natural persons. But, it is limited to business visitors, intra-corporate transferees, and contractual service suppliers.

ASEAN as a single market beyond free flow of goods.

There has been an increasing trend of intra-regional trade being influenced by end consumer demand. This suggests that consumption driven by the growth of middle-income consumers will become a significant driver of ASEAN integration in the future.

But, progress in other areas, such as services has been slow.

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Continuous Integration Faces Challenges

With the rise of China and its increasing global share of trade and FDI, each ASEAN member state has been vying for a larger share of the pie within the region – particularly in FDI and tourism.

The lack of common culture and history appears to have hindered greater regional cooperation. Even with AEC 2015 deadline approaching, there has been minimal cooperation in ASEAN-level FDI attraction and tourism.

ASEAN countries have domestic interest groups that are wary of the potential negative impact of AEC 2015.

The AEC will definitely be launched by 2015. But its impact will only become apparent after 2015.

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RCEP is ASEAN Centric

The Regional Comprehensive Economic Partnership (RCEP) will be comprised of the ASEAN 10 member states plus six others: China, India, Japan, South Korea, Australia and New Zealand. The combined economic output of the bloc reached $21.3 trillion in 2013, which accounts for nearly 30 per cent of the world output.

The RCEP aims to tie together ASEAN’s bilateral free trade agreements with each trading partner. With almost half of the world’s population, RCEP economies represent a massive market.

RCEP negotiation came as Beijing tried to counter progress in the U.S. led Trans-Pacific Partnership (TPP) that excludes China.

China has also proposed in 2014 studying the feasibility of a free- trade agreement in the Asia-Pacific region (FTAPP) which will give China a possibility to claim leadership, as opposed to the U.S. led TPP and the ASEAN centric RCEP. But either TPP or RCEP could be a pathway to FTAPP.

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The Scope & Coverage of RCEP

RCEP goes beyond the ASEAN+1 FTAs:

The RCEP is not an exclusive regional grouping.

Other countries can participate only after the existing 16 countries have completed the negotiations.

Since 2013, SEVEN rounds of

negotiations have been held. Substantial conclusion of negotiations by 2015.

Comprehensive market access; Trade and business facilitation;

Trade remedies;

Economic cooperation; Trade in goods, trade in services

and investments;

Economic and technical cooperation;

Competition policy and Intellectual property rights;

Dispute settlement mechanism;

E-commerce

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Why ASEAN Pushes for RCEP?

Some current ASEAN + 1 FTAs do not provide high-level market access opportunity for ASEAN.

RCEP provides an opportunity to deepen the liberalization commitments in trade in goods, services and rules of origin.

Avoid the ‘spaghetti-bowl’ situation.

The number of ASEAN + 1 FTAs itself is creating a situation which hinders the full utilization of preferential schemes. RCEP can potentially ease this situation.

Facilitate structural reform in certain member countries

If RCEP is successfully concluded, certain member will need to pursue further reform and expand its economic opportunities.

Meeting the deadline is important.

ASEAN will lose its potential economic gains if other multilateral FTAs signed before RCEP because ASEAN’s preference position may erode.

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But Threats to the ASEAN Centrality Exist

ASEAN may not be able to take a unified position.

The development gaps that bring about the differences in economic structures among the 10 countries remain an issue.

If the TPP negotiation moves faster than RCEP, four ASEAN members that join the TPP negotiation may push for more ambitious outcomes in the RCEP while non-TPP members stick to lower targets. This may distract the unity.

Protectionist momentum may impede RCEP negotiation.

The global financial crisis of 2008 has caused not only great recession, but triggered also a world wide protectionist reaction, ASEAN is not immune. Implementation of ASEAN + 1 FTAs therefore can become very sensitive, especially ACFTA.

If such a protectionist sentiment affects the implementation of AEC, ASEAN may decide to delay the RCEP if it’s credibility as a leader in RCEP negotiation is compromised,.

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Economic Relation with China is Critical

China is a major driver of regional integration, a survey by the Economist and ANZ indicates that 41% of Chinese companies say they have a single sales strategy for the entire Asian region.

This is consistent with China’s outbound investment policy, and will certainly be very welcomed by the host countries.

Source: IntegrAsia by the Economist and ANZ

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ASEAN- China Economic Relations

China has been ASEAN’s largest trading partner since 2009. ASEAN has remained China’s third largest trading partner since 2011.

In 2014, China’s trade

with ASEAN grew 8.3%. Bilateral trade value with ASEAN reaches $480.4 billion, accounts for 11.6% share of China’s overall foreign trade.

The bilateral trade value between China and ASEAN is anticipated to achieve $500 billion in 2015, and to $1 trillion

ASEAN Global Trade Flows

by 2020. Source: realinstitutoelcano.org ASEAN trade statistics.

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China’s Economic Diplomacy Affects ASEAN

In 2002, China and 10 ASEAN countries signed the Framework Agreement on ASEAN-China Comprehensive Economic Cooperation and proposed to strengthen the cooperation of economy, trade and investment between the contracting parties. They also agreed on promoting the trade in merchandise and services, realizing trade liberalization gradually, and establishing a China-ASEAN Free Trade Area (CAFTA) by 2010.

As China continues to build up its influence with initiatives such as AIIB、OBOR, and RMB internationalization, ASEAN’s economic relation with China remains critical. if a member decided to develop a stronger partnership with China, it will likely to make ASEAN cooperation less attractive.

The following sections discuss China’s new initiatives.

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III. Challenging Int’l Economic Order:

Does China Have a Mega Strategy?

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China’s Mega Strategy is Taking Shape

China has launched a series of initiatives that appeared to be challenging the existing economic orders. It includes, the “One Belt, One Road” initiative, the reform of existing institutions such as IMF, World Bank, and ADB, and creating new ones including AIIB, and BRICS Development Bank.

China also promotes FTAPP and engages in RCEP negotiation.

RMB internationalization is also part of Beijing’s mega strategy to achieve the peaceful rise of the Middle Kingdom.

Strategic Objectives of “OBOR” Exporting Excessive output capacity and foreign exchange reserve

Expedite the internationalization of RMB

Lessen the dependence on Asia Pacific region

Facilitate China’s economic transformation

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China’s “One Belt One Road” Initiative

The One Belt refers to “the Silk Road Economic Belt”. It will revitalize the original Silk Road which was established in the Han Dynasty (during 206 BCE – 220 AD).

The One Road refers to the 21st Century Maritime Silk Road (MSR) will extend southward from China’s ports, through the South China Sea, the Straight of Malacca to India, the Middle East and East Africa.

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The Silk Road Fund

The “OBOR” initiative is both economic diplomacy, and economic structure reform strategy. OBOR will not only bring a significant commercial impact to countries covered by the initiative, but will also add to the geopolitical complexity now faced with the U.S., Russia, India, Japan.

China will contribute $40 billion to set up “the Silk Road Fund” to boost connectivity across Asia by investing in infrastructure, resources and industrial and financial cooperation.

About 65% of the fund will come from China's foreign exchange reserves. China Investment Corp, the country’s sovereign wealth fund will hold 15% stake in the fund and two other State-owned financial institutions - the Export-Import Bank of China and China Development Bank - will hold the rest of the stake.

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AEC under China’s Maritime Silk Road (MSR)

The idea of the MSR was outlined during Premier Li Keqiang’s speech at the 16th ASEAN-China Summit in Brunei, and President Xi Jinping’s speech in the Indonesian Parliament in October 2013.

These two leaders underlined the need to re-establish the centuries-old seaway as the 21st Century Maritime Silk Road, while celebrating the 10th anniversary of the ASEAN- China strategic partnership.

The main emphasis was placed on stronger and closer economic cooperation, on joint infrastructure projects, the enhancement of security cooperation, and the strengthening of maritime economy, environment technical and scientific cooperation.

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China’s “2+7” Formula for AEC Cooperation

Consensus:

1. deepening strategic trust and exploring neighborly friendship,

2. economic development based on mutual benefits and win-win outcomes.

Seven proposals:

1. Signing the China-ASEAN good neighbor treaty;

2. More effective use of the China-ASEAN Free Trade Area and intensive RCEP negotiations;

3. Acceleration of joint infrastructure projects;

4. Stronger regional financial and risk-prevention cooperation;

5. Closer maritime cooperation;

6. Enhanced collaboration on security; and

7. More intensive people-to-people interactions with increased cultural, scientific and environmental protection cooperation.

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The MSR Initiative is in Line with the Formula

This MSR initiative will be positive efforts to:

boost infrastructure development and structural innovation,

improve business environment of the region,

accelerate development of landlocked countries and remote areas,

lower costs and barriers of trade and investment, and

drive greater reform and opening-up of regional countries.

Moreover, this helps promote ‘silk diplomacy’ with a “soft” aspect of interaction among people, nations, regions, classes and religions; and contribute positive development in Asia.

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With Geopolitical Implications

China also aggressively promotes exporting of its infrastructure capacity and relatively higher end capital goods. The launching of AIIB and BRICS new Development Bank (NDB) will pave the groundwork to further China’s outbound FDI and RMB financing.

The so-called "One Belt, One Road" initiative explores new trade and investment relationship with the countries involved, and promotes the use of RMB.

These initiatives are conducive both to a more balanced development of China’s western regions, and to the strengthening of relationship with countries along OBOR.

OBOR also involves building oil and natural gas pipeline that help secure China’s import.

China’s Energy Security is also on the Line

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Caspian Sea region is rich with oil and gas reserves.

Turkmenistan has pipeline across Uzbekistan and Kazakhstan to China.

Kazakhstan has very rich oil reserve and has the pipeline to China, but doesn’t have Turkmenistan's vast natural gas reserves.

Source: Wikipedia, IEA

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Why China Decides to Create the AIIB?

ADB estimates that the gap in Asia’s infrastructure finance to be around 8 trillion dollars.

The creation of AIIB with focus on infrastructure can help fill the gap as ADB and World Bank need to cover a broad scope of lending, but with insufficient capital.

The implicit reason why China decided to create new institution has been discontent with the extremely slow process in global economic governance reform, as well as continuous suppression by the United States.

AIIB May Only Be the Prelude

China to Lead in Asian Infrastructure Finance

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AIIB leadership will provide China with more diplomatic flexibility. While China has stressed that AIIB will cooperate with the ADB, but leadership at AIIB will allow China more discretion in directing infrastructure finance, which has a major implication as to how individual ASEAN member wish to work with China.

The Asian Development Bank needs real reform. China has urged ADB to increase the capital and allow developing countries an increased representation. There are also suggestions from other members as to how ADB should pursue reform.

Japan and the U.S. led ADB is in a defensive position. ADB president announced at the end of the annual conference that ADB will consult with members on the issue of capital. And to maintain its leadership, ADB has partnered with international banks, on infrastructure projects planning and consultations, and etc.

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BRICS New Development Bank

The BRICS countries formally established New Development Banks (NDB) in 2014, reflecting dissatisfaction with the that industrial countries in the Northern Hemisphere have been in control of the global economic and financial system.

NDB’s headquarters will be located in Shanghai, the first bank president will come from India. NDB does not rule out the possibility to accept more countries in the future.

NDB will have an initial capital of $50 billion, may increase to $100 billion. It already has a reserve of $100 billion (41% of which came from China). 。

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IV. Why China Decided to Take All

These Offensives ?

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China Paid the Price for Its Success

Export-led growth model allowed China to grow its economies successfully and catch up with the U.S.

FX reserves cumulated, however, brought appreciation pressure to RMB. China has intervened massively.

The lack of both the central bank independence and maturity of financial markets resulted in serious distortions and incurred hidden costs. China's foreign financial assets at the end of 2013 is roughly $6

trillion, but the net return on assets, is at best, close to zero, or even negative.

While in-bound FDI has enjoyed a high rate of return, China’s ageing population, together with lower nominal interest rate for China’s international reserves, appreciation of RMB’s real exchange rate, in a time when population in China is rapidly ageing, forced China to revisit its growth model.

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Collateral Damages of China’s Mercantilism

Financial repression provided subsidy to SOEs in China which helped boosted economic growth but a the expense of general public. SOE’s over-investment and low profit margin caused the sovereign contingent liability to go even higher.

As banks serve primarily the SOEs, private enterprises have been forced to rely on the shadow banking system, and bear not only significantly higher funding costs but also periodic roll-over risks.

This mercantilism brings also corruption and environmental challenges to China.

XI Jinping, also made no secret of its dissatisfaction with Western capitalism. He emphasized that China’s “One Belt, One Road" would be based on "righteousness and mutual benefits" rather than the value of Western capitalism.

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China Can Only Engage In Structural Reform

The near melt-down of the global financial system in 2008 has alerted China the risks of having most of its reserve invested in dollar denominated assets.

And the subsequent economic recession since 2009 has led to the deleveraging of most industrialized. The U.S. can no longer absorb the exports from other countries. China’s export-led growth model can no longer sustain, and forced to reform its growth model.

China also has no choice but to change the way it manages the huge FX reserve. This is due to the U.S. shale revolution has made the U.S. energy independent possible, and accordingly current-account deficit might not continue. The consequence is that U.S. will not be issuing sufficient treasury securities to absorb China's trade surplus.

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Pursuing Consumption-led Growth

China adjusted its economy with following policy actions:

To boost domestic consumption and investment first by domestic credit expansion, followed by fiscal stimulus measures, and raised the basic salary.

Allowed the RMB to appreciate and float more rapidly, created a sovereign wealth fund, and encouraged outbound FDI to diversify FX reserve assets simultaneously.

To shrink its current account surplus, accepted a reduced but more reasonable FX position.

To accept a lower GDP growth by reducing subsidies to export-oriented, labor intensive, and environmentally unfriendly manufacturers.

Took action to enable cost reduction of financial repression..

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Diversification of FX Assets

China invests more in developed West and U.S. is China’s preferred destination for outbound FDI.

China's direct investment in global resource sector and infrastructure has increased substantially, in particular, emerging markets and developing countries in Africa and Latin America.

China is expected to become the world’s biggest overseas investor by 2020, and Beijing’s global offshore assets will likely triple from $6.4 trillion, to more than $20 trillion by then, according to a joint research by Rhodium Group and Germany’s Mercator Institute for China Studies.

As a result, China's current-account surplus dropped from 10% of GDP in 2007 to 2.3% 2012, and 2% in 2013. While the U.S. current account deficit has improved from about 6% in 2006 to 2.8% in 2012.

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V. Why Internationalizing RMB ?

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Primary Economic Objectives

Achieve a seigniorage and reduced transaction costs.

Improve China’s monetary autonomy, and defer the costs of economic adjustment.

As the world's biggest exporter, China can reduce currency mismatch in international payment. It can also reflect more accurately China’s increasing influence on international trade and economic relations.

To meet IMF’s criteria of a reserve currency allows China to push domestic reform agenda decisively.

Implicitly, once RMB becomes a major reserve currency, the demand for the dollar assets will consequently decrease, and in the long term will have significant implication for U.S. treasury borrowing costs.

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But not Without Geopolitical Motives

China’s goals to push for RMB internationalization also involves political motives. China seems to be inspired to have the Middle Kingdom rise again as a world superpower.

Increasing demand for RMB denominated assets will progressively impact the demand for dollar assets, and that has a major implication.

China does not foresee its rise to a superpower to be a smooth one. In the case of conflict with the U.S., there’s a potential risk that China might be cut off from SWIFT dollar settlement system.

China tries to minimize the damage caused by such action by relying less on the dollar. This is perhaps why China is rushing to build its RMB international settlement system, called CIPS.

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Creating Demand is the Key to RMB’s Success

China’s Supply side guided currency internationalization has no precedent.

As a currency for investment and trade settlement, RMB needs to be attractive to investors, traders, and other stakeholders.

Demand will be the key to make RMB a reserve currency, and the global environment appears turning more favorable toward RMB.

RMB will need to meet the IMF criteria of economies of scale and free usability to be included in the SDR basket.

Major Reserve Currencies Source: IMF, as of 4/17/2015. 1999 –

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A Three-Prong Approach

To become an investment currency first. RMB will need to become an investment currency first, this will include development of offshore RMB deposits and RMB denominated bonds markets, and also allows the inbound portfolio investment. Its influence will increase progressively in the financial markets. But in the financial markets only.

The use of RMB in international trade and investment. This can be achieved by promoting the use of RMB in export-import. But can be further secured by free trade agreement on either bilateral or regional basis. Once RMB is being widely used in trade and investment, central banks of China’s trading partners will certainly want to keep RMB as a reserve currency.

RMB as a reserve currency. Once RMB is widely used for trade and settlement, and more central banks are taking RMB as a reserve currency, it will then provides China with more influences as a reserve currency issuing country.

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RMB Internationalization Roadmap

Trade and Settlement Currency

Currency swap agreements with more than 32 countries

More than 161 countries use RMB in trade settlement

Rapid growth in RMB denominated trade

Investment Currency From FDI ► to QFIIs ► to QDIIs ► to RQFIIs ► to ?

Reserve Currency

Current account convertibility

Reform of Foreign Exchange System

Capital account convertibility

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RMB Destined to be a Reserve Currency

An investment currency incurs only scattered investment, has only limited influence. A reserve currency can exercise more direct impact with better result.

Global financial markets now have at least 8 to 10 currencies competing as an investment currency.

As a reserve currency, there are only a few to compete with, such as USD, EURO, plus the yen and the pound sterling, it's a lot easier for China to use RMB to exercise its influence. Source：paperblog

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Progress of RMB Internationalization

China now has signed currency swap agreements with 32 countries and territories with the total value hitting 3.1 trillion RMB ($483 billion).

There are now official RMB clearing banks in 16 countries.

RMB overtook the Euro to become the second most used currency in global trade finance after the dollar.

RMB is also one of the top five world payment currencies and the world’s six largest foreign exchange currency.

RMB denominated cross border settlement rose 41.6% yoy to 6.55 trillion RMB in 2014.

RMB settlement volume in outbound direct investment (ODI) increased 117.9 % in 2014 to stand at 186.56 billion RMB, accounting for 26% of the total ODI of the year.

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VI. A Conducive Global Environment

for RMB

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The Structural Changes in Global Trades

The chronic trade deficits of the U.S. because of import of oil and Asian manufacturing products explains the outflow of US dollar.

These dollars usually become the FX reserve of the exporting countries which will flow back to the U.S. when these exporting countries invest in US treasury securities.

The U.S. energy independence has been achieved largely due to shale oil revolution. U.S. trade deficits also improved in a unprecedented fashion over the past decade. As U.S. no longer act as the ultimate consumer, the reduced dollar outflow also lead to the decline of demand for United States treasury securities.

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The GCC Could Weaken the Dollar

Member States of the Gulf Cooperation Council (“GCC” ) all have currency peg to dollar. This is effectively turning over the monetary policy to the U.S. Federal Reserve.

When the Fed adopts an easy monetary policy, the GCC local central banks will be forced to buy more dollars to protect its peg to dollars.

GCC Member states are highly dependent on oil exports, with the currency peg, and fluctuation of the oil price would translate into fluctuations in economic performance of these GCC states.

One way to solve this problem is to give up on the currency peg with the US dollar and appreciate against the dollar. The other possible solution is actually to have the currency peg with another hard currency, such as SDR.

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Peg not to Dollar but to SDR Someday!

GCC states can substantially reduce its dependence on Fed’s monetary policy by having the currency peg to the SDR so that monetary policy of GCC member States will become more concerted in the future with trading partners.

To have the currency peg to the SDR is a logical move as it still has a good portion of US dollar in the basket but allow more diversification to include other major trading partners, including, especially China’s RMB.

China has been promoting the use of RMB in cross border trades, and as GCC states are competing with other oil exporting countries for market share in China since U.S. no longer needs to import oil, GCC is under pressure to export oil to China in RMB, or alternatively, trade in SDR and settled in RMB.

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Relationship Doesn’t Always Last

Saudi Arabia relation with the U.S. is facing headwind.

Obama deserted Saudi ally Egypt‘s Hosni Mubarak, during the 2011 Arab Spring.

Obama failed again to support the efforts to overthrow the Bashar Assad regime in the Syria civil war.

Saudi purchased arms from Russia, imported nuclear technology from Pakistan, and acquired Israel's security assistance.

U.S. nuclear deal with Iran could cause impact.

Saudi Arabia is obviously uneasy with the nuclear deal between U.S. and Iran as it will change the balance of power in the Middle East.

As Saudi cabinet reshuffled, Foreign Minister replaced, and that the new King refused to attend the GCC Summit at Camp David are all signs for concerns.

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Dollar Dominate, For How Much Longer?

As Saudi Arabia reassess its U.S. security relations, with China being the primary destination for GCC’s oil export, and China’s request to use RMB in oil trade, as well as China’s readiness for RMB denominated hedging for oil trade, it will be naive to think that replacing dollar is not on the table.

There is a risk there, despite being a remote one, that once RMB is included in the SDR basket, GCC members might abandon pricing exporting oil in dollar and instead pricing in SDR or Euro and RMB.

Since OPEC countries and commodities exporting countries may follow GCC’s footstep. This could be a real game changer and will have a very significant impact on the future of the international monetary system.

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Crude oil futures contracts settled in RMB

China seeks to build crude oil pricing power：

China is the world's 4th largest oil producer and second- largest oil consumer and importer, but on oil pricing in global markets, China accounted for only about 7%. The fact that the United States has sharply reduced oil imports made China a primary market for oil-exporting countries, and greatly improving the chances of RMB-denominated crude oil imported.

Shanghai International Energy Exchange (INE) will be fully opened to foreign investors

This year, the CSRC will allow the foreign companies to participate crude oil futures trading in Shanghai's free trade area (free trade zone), and that RMB-denominated crude oil futures is expected to pick up substantially.

RMB Based Futures and Commodities Trading

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China will launched other futures contracts to be traded and settled in RMB, commodities such as non-ferrous metals, precious metals and natural rubber.

China has 6 major Futures Exchanges, trading some 40 commodity futures covering agriculture, energy, chemicals and metals, as well as two financial futures.

The CSRC will issue provisional rules on the supervision of foreign investors and futures brokers. Drafting of legislation for futures and commodities is also accelerating.

China is the world's largest gold producer and second largest consumer. Global gold price is currently set at the LME, which has been under scrutiny because of alleged price fixing. Shanghai gold exchange plans to begin RMB- denominated gold trades this year.

Penalizing European Banks Has Consequences

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U.S. government and corporations not only benefited from the low cost funding provided by the dollar, U.S. also uses its reserve currency status as a means to achieve political objectives.

Cutting off North Korea's illicit gain.

Imposed sanctions against Iran, and Cuba: Major European banks were imposed of penalty in billion of dollars by the U.S. as a result.

Sanction against Russia: Russia was cut from international financial markets because of Ukraine crises. Russia companies were forced to turn to other currencies such as euros, RMB and Hong Kong dollars.

China decides to build up its own CIPS RMB settlement system so that it will not be at the mercy of the U.S.

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VII.

Who Will Control the Money?

Dollar, Euro, and RMB

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Crisis of 2008 – A Wake-up Call

Financial crisis of 2008 led to the near collapse of the global market, caused industrialized country's economy to fall into recession, and the epicenter of the crisis was actually from the United States.

Group of 20 (G-20) subsequently agreed to engage in a series of reform programs to correct the flaws in the international financial system which was long dominated by the United States.

Reform of financial supervision. One of the most complex reform was the U.S. Wall Street Reform Act.

Reform of capital rules led by the Bank for International Settlements and the establishment of macro-prudential supervision mechanism promoted by G-20 has also largely been completed.

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Who is delaying reform of IMF?

G-20 Reform program addressing issue of imbalance of governance structure in international financial architecture, including voting power reallocation to better represent the economic reality, has been put on halt largely due to the delay of the U.S. Congress.

Finance Ministers and Central Bank governors of G-20 issued a statement after the IMF spring meeting in April, expressing "deep disappointment", and urged the United States to approve the reform program as soon as possible.

Ibtimes.com

wsj.com

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Transitional IMF Reform Program Urged

According to the reforms program of 2010, IMF weights will be doubled, which some 6% will transfer to emerging market and developing countries, China's weight will be the third-largest, India, and Russia and Brazil share will be among the top ten. U.S. weight will be reduced but retains a 15% veto power on major policy decisions.

Most IMF members have ratified the reform proposal, but delay by the U.S. Congress prompted G-20 to call on the IMF Board to work out a transitional program, so that allocation of the weighting to Member States agreed upon in 2010 can be achieved as soon as possible.

Due to process of negotiation on a transition program may take some time, the review of SDR currency basket becomes the focal point at this time.

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Dollar Dominance Criticized

Dollar is currently the most important currency in the global financial markets. U.S. economic output as a percentage of total global output is 23%, but 43% of global cross-border financial settlement are denominated in dollar, and accounts for 63% of official reserves by global central banks.

US dollars can be subject to domestic economic and policy changes and fluctuations in the United States, obviously is vulnerable to serve as the dominant reserve currency needs.

Zhou Xiaochuan proposed in 2009 "to reform the international monetary system" and emphasized the need to: create and use a supra-sovereign international reserve asset, so that international market can avoid depending on one country's currency which is based on the credit rating and may be vulnerable to different defects.

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SDR as a Supranational Reserve Currency

Zhou specifically proposed the possibilities of converting the special drawing right (SDR) as the foreign exchange reserves, and expand the SDR as a payment instrument, including pricing of securities and commodities, and enhance the functions of the SDR as the main global reserve currency.

As long as the composition of the SDR basket currencies are diversified, and issuance of SDR-denominated bonds will help reduce central banks’ dependence on U.S. treasury securities. The reserve currencies for the new SDR basket will be more diversified and more effective.

As the global reserve currency changes, transactions of oil, commodities, gold and other assets an also be priced in SDR.

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Expanding the SDR Basket

The statement released by the IMF in 2011 on the reform of international reserve currency system is largely consistent with Mr. Zhou's proposal, that is, to seek to develop an alternative to replace the dollar as the world's main reserve currency.

Diversification of the SDR currency basket structure will help reduce the volatility of the global financial system and brings more stability, thus, become the most viable options to replace the dollar.

But to achieve this effect lies in the SDR currency basket structure and distribution of weighting. Expand the coverage of SDR basket to include China’s RMB can certainly better reflect the reality of global economy and can also correct the global imbalance.

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Inclusion of RMB in SDR Basket

IMF reviews the composition of the SDR currency basket and weighting at least once every five years. RMB was regarded as not being able to comply with the criteria of “free usability” in 2010 when IMF reassessed the SDR basket.

But China has made enormous efforts in the past few years, by gradually meeting all criteria, and the chances of RMB being included in the SDR basket has also been enhanced significantly.

Once RMB is included in the SDR, the demand for dollar and US treasury securities will likely be reduced in a significant fashion, and it is unlikely that the U.S. is going to turn a blind eye to the weakening of their global economic dominance.

U.S. Treasury Secretary Jacob Lew has recently said that unless China takes a major reform measure, or else US will not support the inclusion of RMB in the SDR basket.

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Dollar will still be the primary reserve currency

Not every State needs to trade with the U.S. or IMF, but all need to trade mostly in dollars in the global financial system. This makes the U.S. overly complacent, and ignore the international backlash against the hegemony of dollar. This also explains why the U.S. has neglected China's capacity of mega strategic planning and underestimated Beijing’s determination to achieve its goal of a peaceful rise of the Middle Kingdom.

When China starts using these new institutions to cement its trade and investment relationship, when China begins to absorb exports from these countries and turns world’s factory into world markets, and when energy and commodity export to China are traded and settled in RMB, the role of dollar in the global financial system will never be the same again.

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VIII. Conclusion and Implication

for Taiwan

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China’s Economic Diplomacy Makes Impact

As most countries in the world have been overwhelmed by excessive debt, the ultra easing monetary policy by central banks in most industrialized countries has kept the asset bubbles inflating, and the world has yet to see a solid and sustainable economic recovery six years into the recession.

What is needed now from those indebted industrialized countries, is a long overdue structural reform, even in the United States. Because of regional conflicts in the Middle East, events in Europe, and concern of capital flight from Asian economies due to announced eventual normalization of U.S. monetary policy, have regularly caused a flight to safety and a stronger dollar. This subsequently reduced U.S. trade and budget deficits, and allowed U.S. politician to keep kicking the can down the road without hard reform.

China’s various initiatives, funding the infrastructure (AIIB & NDB), developing new markets (OBOR), and promoting regional trade (RCEP & FTAPP), actually have the sufficient scale to boost the global growth, while simultaneously, provide means to guide its domestic structural reform.

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The Pendulum is Swinging Toward China

U.S. underestimated the changing dynamics ?

Whether it is crude oil, commodities, or consumer goods, U.S. can no longer be the consumer of last resort, and is being replaced gradually by China.

China also has the space to provide infrastructure financing to the region, and to the world, in a time when investment in infrastructure is desperately needed in many part of the world.

It’s therefore natural for China to leverage its position to establish RMB first as a major trading and settlement currency, and eventually as a reserve currency.

Who controls money can control the world ?

U.S. politician obviously has no intention to improve its fiscal deficit, as long as foreign governments continue to subsidize U.S. deficit by putting their reserve in U.S. government debt.

But, what happen if the world decides to hold less and less U.S. Treasury securities and takes more RMB assets?

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U.S. Containment Strategy Faces Challenges

Sanction against Russia forced Russia to turn to China for support. EU countries’ sacrifices is not without noise.

Possible nuclear deal with Iran has its geopolitical consequences.

Anti-U.S. sentiment in South American states has not improved.

With memories of 1997 Asian financial crisis, and concern that the Fed’s rate hike may harms, while China offering investment and trade programs, most ASEAN members prefer not to take side.

U.S. took advantage of dollar’s dominate position to executive national policy and penalized European allies caused discontent. Spying on EU leaders certainly didn’t help to ease that situation.

U.S. misjudgment of the changing global dynamics has been illustrated in China’s AIIB and OBOR initiatives. U.S. will need to calculate more carefully how ASEAN is comparing RCEP with TPP, and how the world is perceiving the inclusion of RMB in the SDR basket.

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RCEP Could be More Beneficial to Taiwan

Studies indicated that FTAPP bring more benefits than RCEP, and RCEP brings more than TPP. But, FTAPP likely will be stalled again by the U.S. since it’s led by China.

Regardless of Taiwan’s desire to participate in RCEP, as long as China continues its rise to be a superpower, the diplomatic practice of “any one, but Taiwan” remains.

For China, non-economic motives occupy a distinctive place in trade policy. The ECFA signed between China and Taiwan was designed to reinforce the non-sovereign status of the Republic of China on Taiwan. China classifies ECFA as “arrangements” instead of FTAs between sovereign governments.

China has sought to ensure that Taiwan signs only a minimal number of trade agreements, and not do so as a sovereign state. But this chilling effect has thawed since the ECFA, as evidenced by Taiwan’s agreements with Singapore and New Zealand.

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Taiwan Might be Invited to Join TPP later

China obviously prefers RCEP over TPP as a pathway toward FTAAP. As China at this stage still have difficulties meeting the higher standards required for accession to TPP and that once U.S. raises the bar too high, China will find it difficult to claim leadership in rule-setting for Asia Pacific regional free trade agreement.

With regard to RCEP, since it is by design to be ASEAN centric, China plays an important yet supportive role. Taiwan has more incentives to join RCEP, but it cannot be achieved without giving consideration to China’s influence. But Taiwan certainly needs to continue its efforts in signing bilateral agreements with individual ASEAN members.

TPP has been pursued more as a national security concern than a simple trade issue in the U.S. to counter the rise of China. Taiwan remains a strategic partner for U.S., depends on the development of Sino-US relations, U.S. may decide to invite Taiwan to join TPP at a later stage for strategic reasons.

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Thank You !