Forex Hedging Strategy Protection Against Losses At Gettysburg

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Hay muy pocos equipos interesados ​​en asumir un contrato de ese tamaño para un segunda base que ha jugado su salida de la alineación uno de los peores equipos ofensivos en la MLB. En realidad a un alto nivel de CFD trading y los índices, los contratos es altamente especulativo, las opciones binarias son un comercio eu regulado disfrutando de una eu regulado escalera comercial. Espero ver 52 conferencias con más de 1. En el espíritu del Simposio de hoy, titulado Regulación Financiera: Reflexiones y Proyecciones, planeo reflexionar sobre los eventos que han tenido lugar durante mis años como administrador y luego hacer algunas proyecciones sobre el futuro Tendencias. Mejor Getttsburg a través del valor de volumen efectivo Invertir inmodity Futures Gettysbhrg Invertir hoy Volatilidad Negociación Wall Streets Treasury Buried. 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El lugar video pone la opción binaria sola estrategia de forex que protege la protección contra pérdidas en gettysburg. 95 para hasta 999.999 acciones por comercio, protección contra pérdidas en los síntomas de gettysburg. Seleccionar oferta binaria yealink. La mente no entendió inmediatamente que estás lleno y satisfecho su hambre. Cómo anticipar el comercio Grandes movimientos en el mercado de divisas, por Greg Michalowski 2. Fusionado en este totalmente nuevo innovado. Simple, correcto. La buena voluntad a menudo puede surgir cuando una empresa. Formulario 8. Lo más popular que nunca, los programas de afiliados en: Opciones de afiliados está dispuesto a promover. No hay buenas o malas cuando se analizan las barreras de entrada para una industria en particular. Vendió cualquier ETFs droped de top 10 al día siguiente cerró los precios, y reemplazado con ETFs que hacen en el top 10. De los 17 corredores incluidos en nuestro 2014 Review, sólo OptionsXpress tenía una cuota más alta para la negociación de un contrato. ¿Sabe si hay una manera de saber cuál es el valor de los juegos en el sitio web de Gamestop. Aquí en Littlefish FX trabajamos duro para traerle los mejores indicadores diseñados para mejorar su rentabilidad. Distribuya tarjetas flash, una para cada estudiante o grupo. Siempre es importante leer las revisiones en línea de compañías como esta, sobre todo si la protección contra la cobertura de divisas contra pérdidas en gettysburg va a invertir mucho dinero. Acabados de camuflaje Forex protección de la estrategia de cobertura contra las pérdidas en gettysburg Usa colores moldeados para crear un acabado de camuflaje único Patrones de camuflaje estándar Once patrones de camuflaje básicos son artículos de orden estándar. Opciones binarias sistema de ingeniería corredores 100 mínimo depósito nyse bolsa para el 28 de mayo de 2015 comercio rush opciones binarias estrategia de comercio lista conjunta cuenta de acciones de comercio de la India mercado de valores la próxima semana mejores técnicas de compraventa de divisas capítulo 20 opciones binarias corredores hecho mejores sitios web opción binaria 911 S p opciones binarias Amigo 3 0 cemento-cruzazul por Viernes, sin la motivación de querer realmente conocer los mercados y el comercio, este libro no es para ti. Opciones de formación de comercio, la llamada de oso y la llamada de toro. Cuentas. En primer lugar, iniciar los agentes comerciales utilizando evolutivo. Última edición por Chicken Curry 30-mar-2006 a las 16:51. Este es el único cambio menor hecho a los programas en el ejemplo anterior. Las calificaciones de CANSTAR citadas son protección actual de la estrategia de cobertura de divisas contra pérdidas en gettysburg el momento de escribir en 2015. Cómo negociar corredores de opciones binarias elija aquí. Opción de retirada y disfrutar de ella. Valor de los estados unidos, un día, declaraciones de revelación de productos pds para probar CFD trading que su. De Advantage Trading Group - Tom Cruckshank Sr. Tiempo parcial, cubiertos por su cuenta de jubilación es un plan para adherirse a wordpress. El pago de opciones binarias de comercio produce pagos variados. O una manera fácil de seguir invirtiendo porque estás cansado de perder dinero. Cualquier ganancia potencial debida a los movimientos del precio subyacente debe ser suficiente para compensar los efectos del valor del tiempo y los cambios en la volatilidad implícita. 27 para negociar en 0. 81 de la protección total contra la cobertura de forex japonés contra pérdidas en gettysburg y Japón representa 1. Además de la garantía de devolución de dinero de 60 días, los proveedores de señal de prueba gratuita de riesgo de 14 días es una característica que ha hecho el servicio Altamente atractivo para los comerciantes de todo el mundo. El testigo está excusado. Pero usted está correcto si los tanques de acciones justo después de entrar en la posición, entonces tendría que comprar de nuevo el pone en una pérdida. Makintaki Interesante saytik especialmente quiere resaltar el diseño DeLorean Experimente la eficiencia de los mejores métodos de mejoramiento masculino del mundo AppeLsinka Yo mismo he pensado unos minutos antes de escribir estas pocas palabras. ¿Quién es el culpable y qué hacer? Es nuestro viejo problema el mío que Dostoyevsky dijo. TaLib Youre uno de los pocos que en realidad escribe bien Ursu-S Pocos pueden presumir de tal experto, como la autora Katherine quiero compartir mi exploración con usted. Este mes de compras le trae sólo las ganancias 9 de 10 sobre la base de 38861 ReviewCadwalader Cadwalader: Los más viejos firmas de abogados que operan continuamente en los Estados Unidos. Las propuestas formuladas por la Comisión de la UE el 28 de septiembre de 2011 en relación con una directiva de la UE sobre un sistema común de imposición de las transacciones financieras en los 27 Estados miembros de la UE han sido ampliamente debatidas en las seis semanas posteriores a su presentación. La presentación de la propuesta de Directiva (ldquoDirectiverdquo), junto con las propuestas de modificación de la Directiva 2008/7 / CE, relativas a los impuestos indirectos sobre las capitales, representan la última fase de una serie de anuncios de las autoridades El sector debería contribuir más a los costes de abordar y rectificar la actual crisis financiera europea. Una serie de conclusiones del Consejo Europeo 2. Las comunicaciones dirigidas al Parlamento Europeo 3 y los documentos de trabajo 4 de los servicios de la Comisión de la UE y las consultas celebradas durante 2010 y 2011 han creado una plataforma sobre la cual se han analizado los méritos relativos de diversas opciones para gravar el sector financiero . Esta evolución ha tenido lugar paralelamente a las iniciativas de los Estados miembros (como la tasa bancaria del Reino Unido introducida en la Ley de finanzas de 2011 5) y las discusiones internacionales en las que participan el Fondo Monetario Internacional 6 y el grupo de países del G-20 7. Dado que la profundidad y la naturaleza de la crisis financiera europea continúan evolucionando y los costes de estabilización y recapitalización del sector financiero europeo no muestran signos de disminución, la Directiva llega a un momento político y económico profundamente sensible. Este memorándum considera tanto la mecánica del impuesto sobre las transacciones financieras propuesto (el ldquoFTTrdquo) como algunos de los desafíos que enfrentarán la Comisión de la UE, los gobiernos de los Estados miembros y las instituciones financieras al intentar crear un impuesto viable que alcance los objetivos de sus proponentes . El análisis de este memorándum se basa en la Directiva y en los documentos de apoyo publicados el 28 de septiembre de 2011. Objetivos Los objetivos del ITF han sido declarados por la Comisión Europea como: aumentar los ingresos y obtener una contribución adecuada del sector financiero a Compensar los costes de la crisis financiera, garantizando así una igualdad de condiciones con otros sectores desde una perspectiva fiscal para limitar el comportamiento indeseable del mercado y estabilizar los mercados y asegurar el funcionamiento del mercado interior de la UE y prevenir la fragmentación del mercado interno mediante disparidades unilaterales Iniciativas de los Estados miembros. 8 Estos objetivos se derivan a su vez del razonamiento detrás del ITF que, entre otras cosas, el sector financiero debe asumir su parte justa de los costos de la crisis financiera 9 y que la crisis financiera es atribuible o exacerbada por la crisis sistémica Los riesgos en el sector financiero, entre los que destaca la proliferación de productos financieros y el riesgo de contraparte. Ámbito de aplicación de la base imponible del impuesto sobre transacciones financieras El impuesto sobre las transacciones financieras es un impuesto aplicado a las transacciones financieras en las que al menos una de las partes es una institución financiera y dicha parte u otra parte en la operación financiera está establecida en un Estado miembro de la Unión Europea (a ldquoMember Staterdquo ). Los términos clave "transacción financiera" e "institución financiera" están definidos en la Directiva. No es relevante si la entidad financiera que es parte en la transacción actúa como principal o agente en esa transacción 10. La definición de institución financiera incluye una amplia gama de entidades, entre ellas bancos, entidades de crédito, empresas de seguros y reaseguros, fondos de pensiones, fondos de inversión colectiva de OICVM y sus gestores de inversión, SPV de titulización y otros vehículos especiales y determinadas sociedades de leasing. 11 La amplitud de la definición de institución financiera también puede abarcar a las empresas del Tesoro dentro de los grupos empresariales, lo que apunta hacia una posible incoherencia entre los objetivos de política centrados en el sector financiero subyacentes al ITF y la redacción precisa de la Directiva. 12 Central counterparties for clearing houses, securities depositories, the European Financial Stability Fund and (with an eye to the future, possibly) any ldquointernational financial institution established by two or more Member States which has the purpose to mobilise funding and provide financial assistance to the benefit of its members that are experiencing or threatened by severe financing problemsrdquo are not ldquofinancial institutionsrdquo. 13 Where a person carries on deposit taking, lending, providing guarantees, finance leasing or participates in financial instruments as a ldquosignificant activity in terms of volume or value of financial transactionsrdquo, such a person would also be treated as a financial institution 14 . Financial transactions The FTT taxes a ldquofinancial transactionrdquo. This is defined as being: the sale and purchase of a financial instrument before netting or settlement including repos and securities lending agreements the transfer between group entities of the right to dispose of a financial instrument and any other operation effecting a transfer of risk associated with that instrument and the ldquoconclusion or modificationrdquo of derivatives agreements (the terms ldquoconclusion or modificationrdquo are not further defined in the Directive and no further guidance is given in any of the supporting documentation produced by the EU Commission). The entry into a derivative, any change in its terms, any extension or close out of a derivative, whether cash or physically settled would appear to fall within these concepts and therefore fall within the scope of FTT. Certain types of derivatives, such as variance swaps, reflect daily price changes based on the closing price of the underlying product, so such swaps can arguably be said to be ldquomodifiedrdquo on a daily basis. Any ldquosubsequent cancellation or rectificationrdquo of a financial transaction has no effect on chargeability (except where an error can be proven), with no rebate of previously chargeable tax being available in these circumstances. 15 ldquoFinancial instrumentsrdquo are themselves defined as being the instruments falling within Section C of Annex I of Directive 2004/39/EC (the Markets in Financial Instruments Directive). This definition encompasses a wide range of instruments covering shares, securities (including listed bonds), units or shares in collective investment undertakings, options, futures and other derivatives. Derivatives are included irrespective of whether they are physically or cash-settled and regardless of whether the underlying is itself a financial instrument 16. Both repos and securities lending agreements are expressly defined as ldquofinancial instrumentsrdquo, as are ldquostructured productsrdquo, the latter being securities or other financial instruments offered by way of securitisation 17 or equivalent transactions involving the transfer of risk other than credit risk. The Explanatory Memorandum to the Directive makes it clear that the scope of FTT extends to regulated markets, multi-lateral trading facilities and also over-the-counter trading in financial instruments. Importantly, a number of transactions are excluded from the scope of FTT. The EU Commission has announced that ldquoall transactions in which private individuals or SMEs were involved would fall outside the scope of the taxrdquo 18. Elsewhere reference is made to ldquoring-fencing of the lending and borrowing activities of private households, enterprises or financial institutions and other day-to-day financial activitiesrdquo. 19 The precise scope of this exclusion is currently unclear. It appears that mortgage lending, consumer credit and consumer insurance transactions will fall outside the scope of FTT. However, subsequent trading of these instruments, for example, through securitisations, would fall within the scope of FTT. Other absences from the list of financial instruments include loans, deposits, spot forex transactions, physical commodities and emissions credits. A number of these are surprising given the otherwise broad definition of ldquofinancial instrumentsrdquo. Primary market transactions including the issuance, allotment and subscription of financial instruments are, however, excluded from the scope of FTT. 20 The reason given for the exclusion is ldquoso as not to undermine the raising of capital by governments and companiesrdquo 21. However, the issue and redemption of shares and units in collective investment undertakings and alternative investment funds fall within the scope of FTT. With derivative hedges entered by such funds being subject to FTT and being unable to claim corporate tax deductions for any FTT liability (assuming such funds are exempt from corporate taxes, as is often the case), the taxation of fund issuances, transfers and surrenders is likely to result in UCITS funds and Alternative Investment funds being severely affected by FTT. Transactions with Member States central banking institutions and with the EU or EU institutions (such as the European Central Bank) are also excluded from the FTT. Curiously, transactions with non-Member Statesrsquo central banks (such as the US Federal Reserve Bank of New York) are not excluded. 22 Territoriality For a financial transaction to be within the scope of FTT, two requirements are necessary: (i) at least one party to the transaction must be ldquoestablishedrdquo in the Member States and (ii) a financial institution ldquoestablishedrdquo in a Member State must be a party to the transaction acting either for its own account or as an agent. A number of deeming provisions widen the ostensible scope of the second limb of the test. A financial institution is deemed to be ldquoestablishedrdquo in a Member State if the financial institution has (amongst other factors) its usual residence, permanent address, registered seat, or a branch in that Member State in respect of transactions carried out by that branch. 23 A financial institution will also be deemed to be established in a Member State if it is a party, whether acting as principal or as agent, to a financial transaction with another financial institution established in that Member State, or is a party to a financial transaction with a counterparty established in that Member State which is not a financial institution 24. The practical impact of this condition is to widen significantly the residence and location tests of ldquoestablishmentrdquo. Accordingly, a US bank (being a financial institution) entering into a financial transaction with an EU incorporated company (a non-financial institution) would fall within the charge to FTT as regards that financial transaction. This would be the case even if the financial transaction is entered into by the US bank from New York. The US bank would be liable for any FTT due, with the EU corporate counterparty being jointly and severally liable. One interesting provision in the Directive in this particular regard is that a financial institution will not be treated as being established in a Member State where the person liable to pay FTT is able to show that there is ldquono linkrdquo between the economic substance of the transaction and the territory of any Member State. The term ldquoeconomic substancerdquo is not defined, and it will be interesting to see how and to what extent this provision is amplified or addressed in guidance. 25 Perhaps equally important is the requirement that relief is available only where ldquono linkrdquo exists with the economic substance of the transaction. In circumstances where ldquoeconomic substancerdquo is evaluated by reference to a blend of factors (some of which may be subjective), the absolute prohibition on any link to that economic substance existing is likely to be a demanding test to satisfy. As a result of the broad territorial scope of FTT, non-EU financial institutions with no European presence whatsoever could fall within the ambit of FTT simply because their counterparty is itself established in a Member State. A US bank entering into a derivative under market standard documentation from its New York head office with a bank in the UK would therefore be treated as being ldquoestablishedrdquo in the UK for FTT purposes. The US bank would be liable to pay FTT, with the UK bank being jointly liable. It is submitted that the extra-territorial scope of the definition of ldquoestablishmentrdquo is intentional, and is intended by the EU Commission to act as a deterrent to the migration of financial transactions to non-EU based financial institutions. However, the impact of such a deterrent may be quite limited. The wide territoriality of FTT may prompt non-EU banking groups to incorporate treasury companies outside the EU with which non-EU bank branches or bank group companies can then do business, with the result being avoidance of FTT. 26 Rates and collection FTT will be charged at two rates. While Member States will be able to set their own rate, a minimum rate is proposed to be set at a level which achieves the ldquoharmonization objectiverdquo 27 of the Directive while minimizing the risk of delocalization. The minimum rate of FTT has been set deliberately low to attempt to avoid a negative impact on financial markets. Accordingly, a minimum rate of 0.1 per cent. is the rate of FTT generally charged on the purchase price or other consideration for a financial transaction. In the event that consideration is lower than market price or is the consideration for intra-group transactions, the taxable amount is to be the market price determined at armrsquos length at the date of the FTT charge. A lower minimum rate is to be imposed for derivatives at 0.01 per cent. of the notional amount at the time the derivative is purchased, sold, transferred, concluded or modified. The explanation for this from the EU Commission is that ldquothis approach would allow for a straightforward and easy application of FTT on derivative agreementsrdquo 28. However, it is worth noting that, unlike the price of physical bond, the notional of a swap does not change hands and whilst relevant, is not the only factor determining the cash flows associated with such swap. The time at which FTT is required to be paid to a tax authority of a Member State will depend on the nature of the financial transaction. First, where a transaction is carried out electronically, such as through a clearing system or on an exchange, FTT is payable ldquoat the moment when the financial transaction occursrdquo 29. Clarity will be required as to the date, or time, a transaction ldquooccursrdquo. The most plausible explanation for the term is that occurrence takes place when a clearing system accepts a transaction for clearing. Second, where transactions do not occur electronically, the tax is payable within three working days from the time the tax becomes chargeable. 30 Provisions are also included in the Directive for the filing of monthly returns setting out information relating to FTT during monthly periods. The Directive includes provisions under which the FTT will be included in the network of EU directives focusing on administrative cooperation and mutual assistance in the field of taxation. The Directive also requires that Member States prevent ldquoavoidance, evasion and abuserdquo of the FTT regime, such as artificial division (and resultant reduction) of a derivativersquos notional amount. FTT is payable by each financial institution which is a party to a financial transaction, regardless of whether that financial institution acts as agent or principal. 31 Where a financial institution acts in the name of or for the account of another financial institution in the transaction, only that second financial institution is liable for the FTT. Where a financial institution transacts with a non-financial institution counterparty established in a Member State, the non-financial institution will be jointly and severally liable for the FTT. 32 Member States can also provide that other persons may also be made jointly and severally liable for payment of FTT in addition to the persons identified as being liable in the Directive. Owing to the priority in the Directive of determining the location of the establishment of a financial institution 33. FTT payable in respect of a financial transaction entered into by a bank branch in the EU will be paid to the Member State in which the bankrsquos head office is authorised or incorporated. In the event that the branch funds the head officersquos liability to FTT and claims a corporate tax deduction for that payment, the overall result might be both a reduction of corporation tax revenues for the branchrsquos Member State coupled with the FTT being collected by the tax authority of the Member State in which the bank head office is established. Such a scenario could cause a material adverse impact on revenues of some Member States such as the UK. In circumstances where multiple parties are participating in a transaction, multiple FTT liabilities may arise. For example, where a financial institution acts as agent for a non-financial institution, both could be liable to FTT. Furthermore, transactions are individually subject to FTT. Where a single financial deal includes multiple, smaller, component transactions, each component transaction may be charged with FTT. This cascading effect is imposed even where the multiple transactions are entered into between group members and appears to be intentional. Another example of potential situation where multiple FTT liabilities may have to be considered is a clearing set-up, where one single derivative transaction will result through: (1) one buy-side firm (2) being authorised by its clearing broker (3) to agree the terms of a give up trade with an executing broker (to be ldquogiven uprdquo for clearing) and the other leg of the transaction involves a (4) second buy-side firm, with its own (5) clearing broker and (6) executing broker, where a number of ldquooriginalrdquo, ldquogive-uprdquo and ldquooffsettingrdquo transactions will be deemed to exist for such chain of instruction to produce one cleared transaction. Implementation The proposal is for the FTT to be enabled by legislation in each of the Member States by the end of 2013, with the tax taking effect from 1 January 2014. The introduction of FTT is being proposed under Article 113 of the EU Treaty. As such, the Directive would need to be unanimously approved by each of the Member States. In the event of any Member State vetoing the Directive, as a number of commentators have contemplated that the UK Government may do, the proposals can progress under an enhanced co-operation procedure under which one or more Member States may be authorized to exercise EU non-exclusive competencies through various EU institutions with a view to protecting EU interests and propelling EU integration. It appears that any attempt by Member States to unilaterally introduce the proposals for an FFT are unlikely to succeed for a number of reasons. Legally, such a unilateral adoption would be questionable owing to the provision in Article 401 of the EU VAT Directive 34 which prohibits Member States from maintaining or introducing ldquoturnover taxesrdquo. The question of whether the FTT would constitute a ldquoturnover taxrdquo in the context of Article 401 depends on a number of factors, not least whether the FTT would have the effect of jeopardising the function of the common system of value added tax by being levied on the movement of goods and services and on commercial transactions in a way comparable to VAT. 35 The question is not free from all doubt, and Member States would be wary of any unilateral introduction of an FTT in a manner which might precipitate subsequent legal challenges. Moreover, the EU Commission has identified that unilateral introduction by Member States is likely to be ineffective, citing the example of Swedenrsquos unsuccessful bond transaction tax in 1984 to 1991 period. More generally, any unilateral introduction by a Member State of any tax which may be construed as a ldquoturnover taxrdquo (such as the FTT) would raise concerns within the EU as regards whether such an introduction may be contrary to the fundamental freedoms relating to free movement of capital. The introduction of the FTT would be matched by the withdrawal of other taxes on financial transactions across the EU. Although VAT and insurance premium tax would not be affected, existing taxes such as stamp duties and stamp taxation on securities would almost certainly need to be repealed. This would be welcomed by individual investors and certain funds which currently pay UK stamp duties or stamp taxation on the purchase of UK shares at a rate of 0.5 per cent. of the purchase consideration. Purchasers of UK shares and any securities which are subject to UK stamp taxes which are established outside the EU but which transact with non-EU persons outside the scope of FTT would be able to avoid both FTT and UK stamp taxation. However, these residual benefits have to be set against the prospect of some Member States losing significant stamp taxation revenue 36 . Problems, Uncertainties and Policy Objectives Revenue Raising The provenance of the FTT is readily apparent as being a tax arising from the financial crisis which is aimed at both disincentivising transactions which are perceived to pose a risk to market stability and also eliciting a degree of reparation from the European financial sector. The revenue estimates for the FTT are significant, being predicted as being in the region of euro57 billion per year shared between the Member States 37. The EU Commission Impact Assessment accepts that ldquothe revenue estimates for the variants of FTT heavily depend on the assumption on volume decrease and on the elasticity of remaining trade volumes to the taxrdquo. 38 Unusually for a tax, the effectiveness of the tax in raising revenue is also accepted as resulting in a ldquosmall, but non-trivialrdquo drag on the GDP of the Member States. This is estimated as constituting a reduction in economic output of 1.76 per cent. 39. which is seen as a necessary corollary of ldquocorrecting undesirable market behaviour and thereby stabilizing financial marketsrdquo 40 . However, at a time when growth in many countries in the Eurozone is exceptionally low, it is not unduly pessimistic to suggest that introducing the FTT, with the macroeconomic impacts suggested, may push a number of EU economies towards recession. Moreover, estimates of revenue raised by the FTT appear to be predicated on an absence of widespread relocation of financial transactions to non-EU jurisdictions (a point considered further below) and are highly dependent on the plausibility of the EU Commissionrsquos underlying assumptions as regards avoidance and relocation. The negative impact of the FTT, through an increase in the cost of capital as financial institutions attempt to pass FTT costs to clients, is unlikely to be welcome at a time when the European financial system is focused on liquidity provision, sustainable economic growth and bank recapitalization. An argument may also be advanced that, to the extent that derivatives are often used for hedging purposes and therefore to mitigate risk, the FTT ldquopenalisesrdquo risk reduction instruments that aim to hedge market risk such as FX risk, interest rate risk or credit risk. By disincentivising such hedging instruments, there is a danger that the imposition of the FTT engenders, and does not reduce, systemic market risks. A ldquoPragmatic First Steprdquo Allied to discussion regarding the macro-economic impact of the FTT is a deep concern regarding the delocalization effects of the introduction of the tax. As noted by the EU Commission itself ldquothere are strong economic reasons for a high degree of harmonization and coordination in order to avoid substitution and loopholesrdquo. 41 Furthermore, the Impact Assessment accepts that modern financial transactions are extremely mobile, citing the Swedish financial transactions tax enacted in various forms between 1984 and 1991 as an example of the danger of unilateral introduction. 42 Curiously, however, the proposal for an FTT does not take account of the possible relocation of financial transactions away from the EU. While it is clear that the EU Commission views the FTT as a key component in a global-level financial transaction tax and notes how the proposal for the FTT ldquodemonstrates how an effective FTT can be designed and implementedrdquo and ldquopaves the way towards a coordinated approach with the most relevant international partnersrdquo 43. high hopes and hard realities may prove difficult to reconcile. It is telling that the focus of the EU Commissionrsquos proposals appear to be the G20 group of countries, at least in the first instance. 44 However, given the global integrated market place, it can be strongly argued that unless all key financial jurisdictions (including tax shelters, tax havens and low tax jurisdictions such as Singapore) are included in an FTT, the risk of delocalization may be insurmountable. Although the Impact Assessment accepts that introduction of FTT would come with the risk of ldquorelocation or disappearancerdquo of some transactions (such as high-frequency derivative transactions), the policy objectives behind FTT are unlikely to be achieved if the result of FTT introduction is a wider, systemic dislocation in European financial trading and banking markets. Indeed, at this point it is instructive to re-examine the desirability of a global FTT first expounded by Barry Eichengreen, James Tobin and Charles Wyplosz in their paper ldquo Two cases for sand in the wheels of international finance rdquo (the ldquoTobin Paperrdquo) 45. In the Tobin Paper, the authors identified two situations in which an FTT might be beneficial. The first FTT was intended to be an additional lever in the monetary machine of national governments. In the pre-1971 Bretton-Woods world of exchange rate pegs, exchange controls had been used as a defence by monetary authorities in defending their pegs from speculative ldquoattackrdquo. As countries abandoned their pegs, exchange controls were no longer needed and currencies floated freely against one another. The proposition of Tobin and his co-authors was that relinquishing control of exchange rates also meant relinquishing control over domestic interest rates and that domestic interest rates would therefore be vulnerable to short term volatility in exchange rates. Since exchange controls are not compatible with a free-floating currency, and short term exchange rate volatility was perceived to be undesirable, an FTT was thought to be a way of reducing damaging short term exchange rate volatility. At first glance, it appears difficult to reconcile the underlying intention of the FTT as proposed by the EU Commission with the original aims of Tobin et al . Tobin and his co-authors proposed a global FTT that was aimed solely at foreign exchange transactions. The EU FTT would be neither global nor would it be targeted at foreign exchange transactions (which are outside the scope of the FTT). However, the second case for ldquosand in the wheels of international financerdquo which the Tobin Paper identified, concerned Stage II of the Maastricht Process leading up to European monetary union. A tax analogous to what has now been proposed as the FTT was presented as a means by which the risk of a breach of the EMU convergence criteria, resulting from a speculative ldquoattackrdquo on a currency, could be reduced. Rather than taking effect directly as a tax on forex transactions (which could not be enforced outside the EU), their version of the FTT was to be applied to loans to non-residents by individual Member States. This would have had the effect of indirectly increasing the cost of trading the ERM currencies and, it was thought, deterring short term ldquospeculatorsrdquo. As the authors recognised, however, this would have required a curtailment of the EU Treaty freedoms as it would clearly have discriminated between domestic borrowers and borrowers in other Members States. There are two lessons that might be drawn, however, from the second case given in the Tobin Paper in attempting to unpick the motives of EU Commission policymakers in 2011. Firstly, the FTT can be used as a tool for protecting an exchange rate peg. This puts the focus clearly on the Eurozone countries in the current context as opposed to the wider EU. Secondly, since the former ERM countries no longer have currencies that can be traded, an FTT on forex would be inapplicable 46 but an FTT on other forms of financial instrument used to exploit arbitrage between Eurozone Member States might be of great interest. One of the recurring themes of the European financial crisis has been the volatility of interest spreads of the sovereign debt of peripheral Eurozone countries over Germanyrsquos sovereign debt. It might therefore be expected that shortterm ldquoround-triprdquo transactions relating to the sovereign debt of Eurozone countries 47 are the real focus of the EU Commission and that that, correspondingly, the FTT should be of far more limited relevance to the UK and other non-Eurozone countries. As the UKrsquos financial sector will be acutely aware, however, this reasoning has not been reflected in the drafting of the Directive, which extends to all Member States and not merely the Eurozone countries. Correcting this mis-alignment may well be a priority for lobbyists on behalf of the UK financial sector and, possibly, the UK Government. This sheds some light on the much-publicised tension between the UK and Eurozone in respect of the Directive. The main economic benefit of an FTT identified by Tobin et al is likely to accrue to the Eurozone members. If the scope is widened, the Tobin Paper indicates that there might be some economic benefit in doing this on a global scale but not otherwise (as markets will move elsewhere). The UK could find itself suffering the worst of both worlds, losing a proportion of its international markets in financial instruments as a result of the FTT and receiving no appreciable increase in control over its own monetary policy (when compared to the Eurozone members). Avoidance and Counter-Avoidance Just as there remain a number of uncertainties over the scope of financial instruments that are subject to FTT, it is also unclear at the current time how attempts to restructure financial instruments to fall outside FTT may be counteracted. The Directive provides expressly for the Member States to adopt measures to ldquoprevent tax evasion, avoidance and abuserdquo 48. and it is submitted that much focus will be placed upon the apparent exemption for loan finance, insurance contracts and mortgage lending. Deconstructing a floating rate loan with a derivative hedge into a fixed rate loan or sequence of fixed rate loans would appear to avoid FTT to the extent that loans are not themselves ldquofinancial instrumentsrdquo. Other more sophisticated financial engineering may be possible. Notional amounts of derivatives could be reduced, with a corresponding increase in the quantum of payments under that derivative. Derivatives could also be restructured as cross options, or contracts of insurance, indemnity or guarantee. Other instruments may have their market value reduced through the addition of commercial conditions or restrictions. How planning devices of this nature, long seen in direct tax structures and generally combated through anti-avoidance measures and jurisprudence, would be addressed is uncertain. Structuring transactions around the boundaries of a tax charge is nothing new. However, the importance in the FTT regime of transactions and instruments may be viewed as giving the FTT an inherent vulnerability which might be seen as being out of step with some other forms of taxation (such as service and supply-based taxes) 49. Combating avoidance in this area is unlikely to be straightforward, particularly if the abuse of rights doctrine formulated in the line of cases leading to Halifax 50 is to be deployed. In transactions where lending relationships or insurance contracts 51 are entered into by participants instead of derivatives, it may well be difficult to identify abuse in a Halifax context owing to the likelihood that the financial activity entered into has some explanation other than the mere attainment of tax advantages. Territorial Restructuring In addition to market participants scrutinising the form of their transactions with a view to considering whether careful structuring may avoid the imposition of FTT, the territoriality of FTT may also propel market participants towards restructuring their activities on an entity by entity basis. For a non-EU financial institution, FTT could be mitigated through derivative contracts being effected outside the EU with non-EU counterparties. For EU financial institutions, treasury subsidiaries and SPVs could be established in non-EU territories to prevent the contracting financial institution being subject to tax. Additional analysis will be needed before such planning could be implemented, such as considering carefully the double tax treaty network of the jurisdiction in which the treasury subsidiary or SPV could be located. It is also possible that questions of beneficial ownership of income may be resurrected if such planning becomes widespread, perhaps following the line of arguments advanced in cases such as Indofood 52 and Preacutevost Car 53 . Reducing ldquooverly risky transactions and activitiesrdquo One of the anticipated benefits of the FTT is that the tax will ldquoset incentives to reduce overly risky transactions and activitiesrdquo. 54 The EU Commission has anticipated that the FTT could ldquocurb speculation, noise trading and technical trade, and. decrease marketsrsquo volatilityrdquo. 55 While it is possible that automated high-frequency trading which is undertaken by EU entities and from EU permanent establishments may be driven out of the EU if the FTT in its current form was to be introduced, any reduction in systemic market and financial risk may be outweighed by other negative, behavioural consequences resulting from FTT. For example, the definition of ldquofinancial transactionrdquo would result in transfers of collateral falling within the scope of FTT, and being charged separately on each transfer at the higher rate of 0.1 per cent. applicable to securities. Consequently, and coupled with the exemption of lending transactions from the scope of FTT, the imposition of FTT on posting and transferring collateral may lead to fewer collateralised lending transactions in the form of repos and stock loans and an increase in uncollateralised lending. Such a development is unlikely to add materially to fiscal stability or creditor protection. Derivatives are marked-to-market on a daily basis and as a result, collateral in respect of such daily exposure may get transferred daily during the life of the swap: it is to be hoped that such daily collateral transfers will be excluded from the scope of the FTT. The possible incentives for financial institutions to undertake financial transactions outside the EU, in consequence of the territorial scope of FTT, also appear likely to encourage financing away from regulated, highly capitalised European financial institutions and markets towards less regulated, more thinly capitalised offshore financial centres to which derivative broker/dealers and other market participants may have migrated. Combating such migration will be difficult it would be unrealistic to anticipate that the main offshore financial centres would willingly impose an FTT, at least not in the short term. 56 Furthermore, it is difficult to discern a regulatory and policy approach within the FTT which is contiguous with other EU regulatory initiatives. For example, whereas regulatory initiatives such as the EU Solvency II Directive include extensive measures to determine whether non-EU insurer solvency regimes demonstrate sufficient equivalence to European regulatory requirements, the FTT may result in financial activities being transferred to less-intensively regulated offshore jurisdictions where such equivalence may not yet have been established. A risk therefore exists that the imposition of the FTT might lead to a greater number of uncollateralised and thinly regulated transactions. Such a result is exactly the opposite of the policy objectives articulated by the EU Commission. The Bonfire of the Exemptions Another notable feature of the FTT regime is the lack of exemptions in areas where they might commonly be found in a UK taxation context. In some instances this may be explained by reference to the principles identified in the Tobin Paper and which underlie the FTT (see above), but this is not the case in all situations. For example: The lack of an intra-group exemption: It is hard to envisage a situation where group companies could realise an overall ldquospeculativerdquo profit from round-tripping EU financial instruments or entering into intra-group derivative contracts that are fully hedged by external ones. If all the parties are both within the group and within EU territorial boundaries, all profits on the round-trip transaction might be expected to be exactly offset by an equal amount of losses. Of course, the expectation may be that the profits will arise in lower tax EU jurisdictions and losses may arise in jurisdictions where they can be used to most effect. There is no exemption for intermediaries: This could be interpreted as a symptom of a tax which is targeted at all levels of the market and not just the ultimate investor (in contrast to the regime of SDRT and stamp duty exemptions for intermediaries). There is no exemption for repos or stock lending: Given that stock loans are often the vehicle by which stocks and bonds are ldquoshortedrdquo it may not be surprising that there is no FTT exemption for stock lending. It is less easy to understand the lack of an exemption for repos (and indeed other collateral arrangements) where the purpose of the transfer of the financial instrument is an ancillary purpose of the main transaction. Indeed, repos are often accounted for as secured loans and, in the US, are characterised as such for tax purposes. 57 A mortgage or charge of a financial instrument between members of the same group would also appear to be caught under Article 2.1(1)(b) of the Directive, although it will be difficult in such circumstances to identify any taxable consideration for such a transaction. There is no exemption for loan capital: As mentioned above, while it appears that lending and borrowing by households, private enterprises and financial institutions are not intended to fall within the scope of the FTT, there is no express exemption. Debts which are ldquotransferable securitiesrdquo are subject to the FTT as they will be financial instruments. This is likely to increase the cost of debt finance at a time when the EU as a whole can hardly afford to do so. However, there may be some perceived benefit in disincentivising speculation in bonds issued by Eurozone sovereigns, state backed institutions and other large corporates. Unlike the proposed EU directive dealing with central clearing (EMIR), there is no exemption from FTT for transactions of corporate entities done for the purposes of hedging. Introduction through the VAT system The suggestion has been raised in some corners, and notably by the Conservative MEP Kay Swinburne, that the EU Commission is looking at ways in which an FTT might be introduced within the current EU VAT regime. 58 The purported attraction for the EU Commission is that this would enable the objections of the minority to the Directive, especially the UK, to be circumvented through qualified majority voting. However, such an approach would present considerable difficulties. It should also be said that while this is an interesting idea, a VAT-based FTT is likely to prove a misplaced concern due to the unlikelihood that such an approach would achieve all, if any, of the FTTrsquos goals. Assuming that FTT would not be regarded as a turnover tax, 59 the result of removing transactions in financial instruments from the scope of the VAT exemption could result in a number of perverse consequences. For example: The abolition or the narrowing of the finance exemption will result in greater recovery of unattributable input tax for partially exempt entities and full recovery of input tax attributable to the newly taxable transactions. It is, of course, a misconception to regard the finance exemption as an exemption for financial institutions. It is rather an exemption for consumers which is, effectively, paid for by financial institutions who in turn may pass that cost to consumers through higher fees. Removing the exemption would clearly not achieve the EU Commissionrsquos aim of seeking a fair contribution from financial institutions in this respect. Notwithstanding the point above, the initiative might raise no extra VAT at all if private consumption remains exempt. Since VAT is a tax which falls ultimately on the consumer, extra tax would only be forthcoming where consumers paid irrecoverable VAT on their finance costs. The prospect of voters paying VAT on their mortgages across the EU is unlikely to be appealing on a national level. If the principle that private individuals should be excluded from the scope of FTT is extended to an analogous VAT amendment, either the exemption would have to remain in place for transactions with non-taxable persons or those transactions could be zero-rated. Since zero-rating would result in full recovery of attributable input tax, this is likely to be revenue-negative across the EU. Narrowing the scope of the exemption to consumer credit transactions, might be revenue positive but only where value is actually being added in the chain of credit transactions which are removed from the scope of the exemption. Broadly, the effect of such a move would be to subject a proportion of the financial institutionrsquos profits to VAT. However, it should also be remembered that this might result in large VAT rebates for loss-making institutions, particularly those which have been rescued and recapitalised at the taxpayerrsquos expense. Subjecting the value-added in finance transactions, and the consideration for the end product, to VAT would be tantamount to raising interest rates. This could have an adverse effect on the EUrsquos economy as a whole. The application of VAT to financial instruments is unlikely to have any effect on the systemic stability of financial markets. While the administrative burden in relation to the issuance of invoices may increase, this in itself may not have an appreciable deterrent effect in relation to high-frequency, speculative transactions. It therefore becomes clear, when comparing a VAT-based approach to the objectives of the EU Commission, that using the VAT system in this way is not going to present an easy solution which will deliver the desired results. There are also difficulties in measuring ldquovalue-addedrdquo in relation to financial transactions, and determining what lies outside the scope of VAT altogether, which are conveniently avoided by the current finance exemption. Policy Asymmetries As can be seen, there are some self-evident policy asymmetries and inconsistencies at the heart of the FTT proposals. However, there does appear to be some logic in favour of an FTT when it is viewed as ldquothrowing sand in the wheelsrdquo of international or EU-wide finance. Examining each objective in turn: The FTT is meant to ensure that financial institutions make a ldquofair contributionrdquo to covering the costs of the economic crisis. There are two difficulties in accepting this objective at face value. Firstly, the EU Commission itself estimates that the FTT will reduce GDP by 1.76 per cent. which, based on Eurostatrsquos GDP figures for 2010, 60 implies a cost of 286 billion. This compares poorly with the modest estimates of what the FTT might raise and suggests that the FTT may not raise revenue once the negative impact on other tax revenues is taken into account. Secondly, FTT revenue will not contribute to covering the cost to individual member states of the economic crisis but is proposed as an addition to the EU budget. The FTT is designed to avoid fragmentation in the market for financial services, ldquobearing in mind the increasing number of uncoordinated national tax measures being put in placerdquo. It is true that the FTT would result in harmonisation, but this argument might be made in respect of any tax measure. Furthermore, while the EU is a customs union its remit is not to impose capital controls which, arguably, the FTT may be construed as achieving in substance if not in form. In addition, although members of the Eurozone have a vested interest in discouraging transactions which tend to undermine the stability of monetary union, it is difficult to see why it is any more essential that the UK, being outside the Eurozone but within the EU, should implement an FTT than, say, the US. The FTT is meant to ldquocreate appropriate disincentives for transactions that do not enhance the efficiency of financial marketsrdquo. As already discussed above, this objective appears to have its roots in the economic theory behind the so-called ldquoTobin taxesrdquo. The FTT could be expected to disproportionately affect the lower-margin, high frequency transactions. It is therefore possible that this is where the real value of an FTT lies. If the EU Commission believes firmly that an FTT would be of value in promoting the stability of the Eurozone by removing speculative elements from the market for sovereign debt obligations, it is possible that the Eurozone states will explore the potential for introducing an FTT using the enhanced co-operation procedure under Article 326 of the EU Treaty. While the enhanced cooperation must comply with the rights of Member States which do not participate, there does not appear to be any significant impediment to the Eurozone states introducing an FTT as a group (unless the FTT could be regarded as a turnover tax prohibited by Article 401 of the VAT Recast Directive 2006/112/EC). Application in Practice: Some Examples In order to illustrate the transactional boundaries of FTT more clearly, some examples as to how FTT might apply to a range of financial transactions between ldquofinancial institutionsrdquo follow. As can be seen, the scheme of the Directive can lead to surprising results for transactions which may have little connection with the EU. A financial institution based in the US enters into a credit default swap with the New York branch of a German bank in respect of Chilean government bonds. FTT may not apply to the German bank under Article 3.1(b) and (c) or the US bank under Article 3.1(e) as a result of the exemption at Article 3.3 which provides an exemption from FTT where there is ldquono link between the economic substance of the transaction and the territory of any member staterdquo. However, any credit support arrangements relating to the swap may also need to be considered with care in the event that collateral is provided by the German bankrsquos head office or where the collateral itself is issued by an EU issuer: A US bank enters into a credit default swap with the New York branch of a German bank in respect of Greek government bonds. FTT would be payable at 0.01 per cent in Germany by both the German bank under Article 3.1(b) and (c) and the US bank under Article 3.1(e) as the exemption at Article 3.3 is unlikely to apply due to the nature of the reference obligation (It is submitted that strong arguments may be made that there is no economic connection between the New York branch of the German bank, the US bank and an EU member state if the Greek government bonds are perceived as merely a variable which influences the payments under the credit default swap. However, it is also submitted that the approach of the EU commission appears to be, from a policy perspective, that such transactions should fall within the scope of the FTT): The US subsidiary of a UK bank purchases German bunds from a Singaporean subsidiary of a French bank. No FTT should be payable as neither subsidiary (even if constituting a ldquofinancial institutionrdquo) is treated as ldquoestablishedrdquo in a Member State: The Paris branch of a US bank enters into a repo of US Treasuries with the Federal Reserve Bank of New York. FTT of 0.1 per cent would be payable in France on the transfer of US Treasuries on both legs of the repo by both parties: On the basis of the current drafting of the Directive, it would seem that the purchase and sale of a bond might be subject to six separate charges to FTT. For example, two financial institutions may each have an account with a clearing system. Two other financial institutions (SPV1 and SPV2) may, for differing reasons, wish to purchase or sell (respectively) a particular bond which is immobilised in the clearing system. The trade is effected by the account holding institutions as custodian, in each case, upon the instructions of the investment manager acting for SPV1 and SPV2. Since (i) the trade is carried out for the account of SPV1 and SPV2, in each case, (ii) the financial institutions are party to the transaction for the account of the SPVs, and (iii) the investment managers are acting in the name of the SPVs, a charge of 0.1 per cent could arise on each of the six participants in the trade: Conclusion The European Council discussed the Directive on both 11 October and 26 October 2011. Further discussion of the Directive was undertaken by the European Council of Finance Minsters (ldquoECOFINrdquo) in Brussels on 8 November 2011. Formal discussions have also be accompanied by widely reported press statements in support of the FTT by Algirdas Scaronemeta, the EU Commissioner responsible for taxation and customs union, audit and anti-fraud, and by a number of leading politicians, perhaps most notably Dr. Wolfgang Schaumluble, the German Minister of Finance. A variety of commentators, politicians, lobbyists and interested parties have also given their (generally adverse) views of the proposals. Discussions also took place regarding the merits and practicalities of a global financial transaction tax at the G-20 summit in Cannes on 3-4 November 2011. However, overshadowed by the on-going crisis in the Eurozone and in particular regarding the impact of that crisis on Greece, little progress was made regarding global introduction of a financial transaction tax. Notwithstanding forceful advocacy by France, it appears that a large number of G-20 nations including the United States, Britain and Canada remained concerned during the G-20 discussions about the practicalities of introducing a tax on a global scale and (in the case of the United States) preferred to follow a different approach to seeking contributions from the financial sector for the costs of the financial crisis. 61 Divisions have also, perhaps unsurprisingly, emerged between the Member States. In early November 2011, the UK Government publically stated that it would only endorse an international version of FTT, and would not support an EU-wide introduction alone. 62 Citing concerns over the use of revenues raised by the FTT, the UK Governments opposition to the tax appears to be matched by serious concerns in Sweden over whether the FTT is credible at a time when the focus in the European Union is on growth and attracting business. 63 Although the finance ministers of Spain, Belgium and Austria have suggested that the implementation of a financial transactions tax would be viable across the 17 members of the Eurozone, both Irelandrsquos Finance Minister, Michael Noonan, and European Commission President, Joseacute Manuel Barroso, have distanced themselves from such a move. 64 It now seems likely that, following the ECOFIN meeting on 8 November 2011, the proposed Directive will remain in limbo pending further discussion by the EU Commission and ECOFIN in the first half of 2012. It is possible that in any future discussions regarding the FTT in 2012, the EU Commissionrsquos position may evolve as concessions are sought from Member States and negotiating positions are refined. A similar evolution was seen in the genesis of the EU Savings Income Directive, with the original proposed directive presented by the EU Commission in March 1998 on a common system of taxation applicable to savings income being highly controversial and potentially unworkable. 65 Following intensive discussions at both political and technical levels during the period from 1998 to 2000, the approach of the EU Council to the draft directive developed, with the final version of the directive adopted on 3 June 2003 66 including a number of material differences to the 1998 draft, and being markedly more practical and workable as a result. Many financial institutions, and one suspects some Member State governments, may be hoping that something similar happens as regards this Directive. 1 EU Commission Explanatory Memorandum on the Directive (the ldquo Explanatory Memorandum rdquo), paragraph 1.1, page 2. 2 Council of the European Union, 17 June 2010. 34 EU VAT Directive 2006/112/EC. 35 KoumlGAacuteZ rt and others v Zala Megyei Koumlzigazgataacutesi Hivatel Vezetoje OTP Garancia Biztosiacutetoacute rt v Vas Megvei Koumlzigazgataacutesi Hivatal (Joined cases C-283/06 and C-312/06) Rousseau Wilmot SA v Caisse de Compensation de lrsquoOrganisation autonome nationale de lrsquoindustrie et du commerce (Organic) (Case 295/84) 1985 ECR 3759, ECJ. 36 The yield from UK stamp duty and stamp duty reserve tax in 2009/2010 was calculated at GBP pound2 billion. 37 See Impact Assessment, paragraph 7.8. Estimates of the revenue raised through the FTT ranges between euro16.4 billion (a 0.01 rate and assumption of high volume decrease) and euro433.9 billion (with a rate of 0.1 and an assumption of low volume decrease). 38 See Impact Assessment, paragraph 7.8. 39 See Impact Assessment, paragraph 7.8.. 40 See Impact Assessment, paragraph 6.3. 41 See Impact Assessment, paragraph 7.7. 42 The Swedish tax on equity securities, fixed income securities and financial derivatives, imposed between 1984 and 1991, led to disappointing tax revenues, a fall in Swedish share prices and a very significant fall in market trading. During the first week of the tax, the volume of bond trading in Sweden fell by 85 per cent. During the period of the tax, the volume of futures trading fell by 98 per cent. and the Swedish options trading market disappeared. (ldquoTransaction Taxes and the Behaviour of the Swedish Stock Marketrdquo, S. Umlauf, Journal of Financial Economics 33 . pp 227-240). 43 Explanatory Memorandum, paragraph 1.4. 44 See the Explanatory Memorandum, paragraph 1.4, and note the focus on the ldquo most relevant international partners rdquo, an expression at least suggestive of the proposal being discussed at the G-20 summit meeting in November 2011. 45 ldquoTwo cases for sand in the wheels of international financerdquo, The Economic Journal . Vol 105, Issue 428 (Jan 1995), 162-172. 46 Which may explain why forex transactions are outside the scope of the FTT. 47 Including derivatives written over, and repos and stock loans of, such debt and of the debt of state-backed institutions. 48 Directive, Article 11.1. 49 Interesting comparisons might also be drawn with measures used by the UK Government to counteract and combat stamp taxation planning schemes prior to the introduction of stamp duty land tax in 2003. 50 Halifax plc v Customs and Excise Commissioners 2006 STC 919, ECJ Case C-255/02 51 The incidence of insurance premium tax would need to be lower, if not mitigated entirely, than the potential FTT for the transaction in question before such a restructuring was worthwhile. 52 Indofood International Finance Limited v JPMorgan Chase Bank NA London Branch 2006 EWCA Civ 158 53 Preacutevost Car Inc. v The Queen ( 2008 TCC 231). 54 Algirdas Scaronemeta, EU Commissioner for Taxation and Customs Union, Audit and Anti-Fraud, speaking at the FEE Tax Day 2011 Brussels, 11 October 2011: ldquo EU tax policy in support of the EU 2020 Growth Strategy rdquo. 55 Impact Assessment, paragraph 7.8 ldquo Risk-taking and behavioural effectsrdquo. 56 It is tempting to contemplate that a G-20 adoption of a financial transaction tax along the lines of the FTT could lead to a global adoption of that tax, including by offshore financial centres. However, such a unified adoption of a global tax would be a lengthy process. The precedents for such a measure are unappealing global measures to combat climate change have been notoriously difficult to achieve as the UN Climate Change Conference in Copenhagen in December 2009 demonstrated. 57 Nebraska Department of Revenue v Lowenstein . 513 U. S. 123 (1994). 58 See, for example: ldquoMEPs plot way to get tax past UKrsquos vetordquo, The Daily Telegraph . 4 October 2011. 59 Which is prohibited by Article 401 of the VAT Directive (2006/112/EC). 60 16,242,256 million in 2010 according to the IMF, see imf. org. 61 ldquo G20 fails to endorse financial transaction tax rdquo Reuters, 4 November 2011. The G20 Summit Final Communiqueacute, at paragraph 28, included the anodyne statement that ldquoWe acknowledge the initiatives in some of our countries to tax the financial sector for various purposes, including a financial transactions tax, inter alia to support developmentrdquo. 62 ldquo Europe confused on financial transactions tax ndash UK rdquo, Reuters, 7 November 2011 ldquo Osborne says UK is opposed to EU financial transaction tax rdquo, Bloomberg, 27 October 2011. 63 ldquo Fekter, Reynders endorse Euro-area financial transaction tax rdquo, Business Week, 8 November 2011. 64 ldquo No EU deal on transaction tax ndash Noonan rdquo, Irish Times 8 November 2011 ldquo Fekter, Reynders endorse Euro-area financial transaction tax rdquo, Business Week, 8 November 2011. 65 See ldquo Comments on the Directive 2003/48/EC on the Taxation of Savings rdquo, Albert J. Raumldler, Casa Editrice Dott. Antonio Milani, 2005. 66 Directive 2003/48/EC on taxation of savings income in the form of interest payments. PART IV: China Steady on the peg This article appeared in AToL on December 1, 2004 Chinese Prime Minister Wen Jiabao has criticized the US for not taking measures to halt the dollars slide and made it clear that China would not revalue the yuan under pressure. You must consider the impact on Chinas economy and society and also the impact on the region and the world, Wen said in Laos late Sunday on the sidelines of the Association of Southeast Asian Nations (ASEAN) meet when asked about pressures to change the yuans decade-old peg to the dollar. Wen also signaled that speculation was too rife in the market at the moment to make such a change. The announcement was timely as China stands at the crossroads of economic destiny, the direction of which will determine if it will be the latest victim of bankrupt neo-liberal ideology or the sole survivor that manages to develop an effective immunity from the deadly financial virus of dollar hegemony that regularly assaults all economies. On a strategic level, China, the most populous nation on Earth, cannot possibly expect to develop toward world-class living standards by exporting to a rich minority of the worlds population. The poor economies excessive dependence on export to the rich economies under dollar hegemony will perpetuate the maldistribution of wealth on a global scale and put China permanently on the lower end of that scale. For a small, rich segment of the worlds population to be the engine of growth for the entire global economy by consuming the products made by a poor majority is a formula of global financial imperialism. Financial imperialism is an advanced stage of old-time industrial imperialism. Nineteenth-century industrial imperialism of the British model at least produced industrialized products at the core out of raw material from undeveloped colonies. Twenty-first-century finance imperialism of the neo-liberal model uses financial manipulation to make industrialized colonies produce everything in exchange for fiat money in the form of dollars. Imperialism, now and then In contrast to industrial imperialism under which the imperialist economy exports value-added manufactured products for gold, with which to finance more new modern factories at home, the financial imperialist economy imports value-added products from the colonies and pays for them with fiat paper. The colonial economies now export real wealth in the form of value-added products and get paper in return. To make matters worse, under dollar hegemony, the fiat paper currency, in the form of dollars, can only be re-invested in the dollar economy, not non-dollar exporting economies. Exporting for dollars is merely shipping wealth out of the exporting economy to the dollar economy. The dollar economy has become the luxurious front office of the global economy. Both forms of imperialism sustain favorable trade terms with the colonies through political coercion. A sustained trade deficit supported by currency hegemony is the essence of finance imperialism. Unlike producers in the industrialized core during industrial imperialism, producers in the colonies under finance imperialism do not get richer from producing. They are locked into a low-wage sweatshop production system so that global inflation can be contained to keep an ever-expanding supply of fiat dollars valuable. Credit is allotted through a central bank regime not to the entrepreneurs who can keep wages rising, but to those who can succeed in pushing wages down with government blessings. The more dollars the Federal Reserve releases, the lower world wages must fall to prevent global inflation. The more the dollar economy expands, the smaller the wage-to-price ratio in dollar terms. Those economies that defy this iron law of low wages under dollar hegemony are punished with financial crises that drain their dollar reserves. Dollar hegemony renders domestic Keynesian demand management inoperative. It is no longer economically necessary to manage demand by raising wages even at the financial core, since consumption can be maintained by lowering prices of products produced at low-wage peripheries, paid for by the wealth effect of dollar assets buoyed by a rising tide of fiat dollars that the Fed can release without limits and with no penalty or reckoning. Thus under dollar hegemony, money takes on an additional function as a confiscatory tax on wages, apart from the conventional functions of store of value and medium of exchange. This confiscatory role of money on wages works across all national borders, spreading and perpetuating poverty on the working class all over the entire globe. Neo-liberal economists call it wage arbitrage natural to finance market fundamentalism. They put forward the argument that workers are not unjustly exploited by imperialists or capitalists. The dismal fate of workers under dollar hegemony, in a neo-Ricardian iron law of wages, is the logical outcome of a Hayackian amoral market scientism. The law of the financial jungle has become the ideal of the capitalist civilization. Thus socialist China can move toward a socialist market economy without any sense of guilt of betraying its socialist revolution, all in the name of neo-liberal modernization. In the US, displaced workers blame low-wage workers overseas, rather than dollar hegemony, for the predictable fate for workers everywhere. Domestic class conflict is transformed into nationalistic feuds between workers in conflicting national economies. Dollar hegemony prevents non-dollar economies from developing their economies with sovereign credit denominated in local currencies to finance full employment and rising wages. Dollar hegemony, operating through unregulated foreign exchange markets, neutralizes the purchase power disparity between economies and makes it profitable to outsource high-paying jobs from the US. Chinas move toward market economy along neo-liberal lines was originally intended to be a brief and temporary program to kick-start its economy off the stagnation caused by decades of hostile US containment and embargo, made worse by domestic ultra-radical excesses typical of a garrison state. But the temporary corrective expediency turned into a permanent revisionist policy that inevitably led to political instability. The pressure exploded in the Tiananmen incident in 1989, a decade after the launching of Chinas temporary economic reform. Misled by biased Western media with an agenda separate from the target, adverse international reaction on Tiananmen reverberated around the world, causing intense hostility toward socialist China, particularly from the Western anti-communist left, whose members denounced the Chinese government as being repressive of democracy, ignoring the fact that the real culprit was a policy drift toward market capitalism away from socialist planning. The historical fact was that Tiananmen began as a student mass movement to arrest the erosion of socialism in China. Domestically, the real tragedy of Tiananmen was not the alleged abortion of latent bourgeois democracy, as the Western media tried to spin it. It was the ossification of a brief transitory strategy of market liberalization in order to build better socialism into a lasting policy of permanently postponing socialist construction. This policy is rationalized with all kind of revisionist ideological mumbo-jumbo, such as China must first go through a long capitalist stage before it can move onto a socialist stage, and let some people get rich first. The word first was then conveniently drop and the slogan became: let some people get rich, period. Yet there is solid evidence that China has successfully leapfrogged into the space age without repeating the costly experimentation of another century of the sub-orbital aviation. It is then a puzzle why socialism has to be postponed and wait for its gradual evolution from a restoration of capitalism. There is no logic in insisting on repeating the mistakes of the capitalist West by copying a bankrupt market system bent on recurring self-destruction. Yet Margaret Thatchers fanatic TINA (there is no alternative) mantra is accepted as the gospel of truth. Income disparity and wealth maldistribution natural to market economies are celebrated as necessary dynamos of prosperity. Economics, unlike truth-respecting physics from which it pilfered many theoretical concepts, tends to hang on to obsolete ideas long proved dysfunctional by events with ever more sophisticated rationalization. While Issac Newton is now a relic in the history of physics, Adam Smith is alive and well in the temples of economic thought more than two centuries after his time. China, after half a century of socialist revolutionary struggle, also swallowed the neo-liberal propaganda that only market capitalism can bring prosperity. The Tiananmen tragedy The tragedy of Tiananmen in 1989 is that it sounded the death knell of socialist revolution and heralded the restoration of capitalism in China. Tiananmen began as a backlash grassroots political reaction to wholesale official rejection of socialist principles and ideology. The students at the beginning of the Tiananmen incident protested against the ill effects of the introduction of market fundamentalism in the Chinese economy. They wanted to preserve full government financial support for education, particularly generous socialist benefits for students, and protested against high unemployment, income inequality and widespread corruption associated with the move toward market economy. Such demands at first received sympathetic hearings from the top leadership. Alas, wholesome student sentiments were quickly manipulated to turn intransigent by the US media at the scene to cover the state visit of president Mikhail Gorbachev of the USSR in its final stage of implosion, taking on the form of counter-revolutionary demands for political liberalization toward bourgeois democracy. While the students were actually demanding more government protection from the erosion of socialist rights and privileges gained for them by their heroic parents, the Western media distorted the student protests as demands for free markets and bourgeois democracy. Naive protesters were selectively featured by the US media on global television to recite Abraham Lincolns Gettysburg Address in broken English, never mind that the speakers obviously had no understanding of US history and politics, let alone the statist and interventionist context of Lincolns inspiring words. The leadership in the Communist Party of China (CPC) at that historical moment was divided. While some remained sympathetic to a student movement to preserve socialism, others found it imperative to decisively crush a manipulated political revolt against a socialist government. In a fateful turn of tactics in the aftermath of the resultant tragic violence, the CPC leadership decided to preserve political control through further market liberalization, thus forfeiting its equalitarian socialist mandate in favor of authoritative institutional economics based on administrative intervention on free markets. A decade and a half after Tiananmen, the CPC is now forced to officially acknowledge the problem of the continued ability of the CPC to govern effectively. The phrase zhi zheng neng li (governance capability) surfaced in mid-September 2004, when the CPC Central Committee was reported by The Peoples Daily as discussing the cultivation of the ruling partys governing competence. The authoritative paper noted that it was the first time during the 55 years of history after the new China was founded that the countrys ruling elite considered how to improve the partys governance ability at an annual plenum of the central committee. It is a conceptual oxymoron for a communist party to govern a market economy. Yet despite all the ideological, strategic and tactic errors of the past three decades, the CPC is far from being an irrelevant political institution as it remains the only political organization with the determination and ability to preserve the territorial integrity and independent sovereignty of China. The history of the Chinese economy shows that most periods of prosperity in four millennia had operated under the socialist principle of a commonwealth of Great Harmony ( Da-tong ) as opposed to the capitalist principle of petty bourgeoisie ( Xiao-kang ). The realities of Chinese society will soon turn the CPC back on its historic socialist track and wake up its leadership from the fantasy that only market capitalism can effectively mobilize the masses for national construction. Market fundamentalism will only lead China to fall again into its past dismal fate under the Kuomintang, whose socialist path had been diverted with the assassination on August 20, 1925, of leftist leader Liao Zhong-kai after the death of Sun Yat-sen, resulting in a bankrupt economy that provided the socio-economic backdrop for continuing semi-colonial exploitation by Western powers and the rise of the CPC as a liberating force for national revival. But dollar hegemony injures not only the working class. Even the comprador class of finance imperialism is also periodically stripped of their ill-gained wealth by recurring financial crises caused by dollar hegemony. Still the multi-trillion dollar losses from the recurring financial crises and bubble bursts of past decades circling the globe did not all come from the rich. Some of it came from the hard work for low pay of the working poor, funneled to the rich through structural systemic economic injustice disguised as market forces. But most of it came from institutional depositories of worker pensions. Young workers are being forced to pay for the systemic losses of financial crises through the loss of jobs and reduction of benefits their parents once enjoyed. Retired workers are also forced to pay for the systemic losses through drastic shrinkage in the value of their retirement nest eggs. The enviable workers benefits won through century-long struggles of labor organization in the industrialized core have been swept away by neo-liberalism in the name of competitiveness, while workers in the emerging economies are deprived of the minimum social progress their counterparts in the advanced economies already won a century ago. Under neo-liberalism, even if and when the Chinese economy should finally catch up with the US economy, which under dollar hegemony is in theory equivalent to trying to catch up with ones own shadow in a setting sun, what Chinese workers have waiting for them at the end of the market fundamentalism rainbow is not a pot of gold, but the same dismal fate facing the US workers today, ie, to have their jobs outsourced to another still-lower-wage economy. Chinas industrial heartland will look like the rust belt in the US, where high-pay factory jobs have disappeared to low-wage economies and once-booming factories sold for scrap metal. Race to the bottom The result will be a global economy of more severe overcapacity, with wages too low and jobs too scarce to provide the purchasing power to buy the products workers produce. There was a time when a government printed money recklessly and hyperinflation would follow. Now, under dollar hegemony, when the US Federal Reserve prints dollars, inflation is kept under control by outsourcing high-wage jobs to low-wage economies while wealth becomes increasingly concentrated. Neo-liberal economists fail to understand that money is useless unless broadly distributed and spent. Neo-liberal monetary policies tend to inject liquidity only on the supply side as investment, an obviously wrong target in an overcapacity economy. Overcapacity is a direct outcome of excess return on capital from regressively low wage schemes. Liquidity should be injected to support demand management, by providing full employment with rising wages until overcapacity is eliminated. Unregulated credit markets inevitably become failed markets by directing credit where it is least constructive. In China, the 1995 Central Bank Law granted the Peoples Bank of China (PBoC) central bank status, changing it from its historical role of a national bank in a planned economy. Central banking insulates monetary policy from national economic policy by prioritizing the preservation of the value of money over the monetary needs of a sound national economy. The ideological assumption asserts that a sound currency is the sine qua non of a sound economy. It is an assumption that is neither logically true nor empirically supported. A global international finance architecture based on an unregulated currency market with full convertibility at market rates in the context of universal central banking allows an increasingly volatile foreign exchange market to facilitate the instant cross-border ebb and flow of capital and debt. This instant cross-border flow of funds can be devastatingly destructive with little advance warning. Central banking thus relies on domestic fiscal austerity and monetary contraction imposed through high interest rates to achieve its institutional mandate of maintaining the exchange value of the local currency and to prevent destabilizing fund outflow. In contrast, a national bank does not seek independence from the government policy. National banking views itself as in a supportive role of national economic policy. Independence of central banks is a euphemism for a shift from institutional loyalty to economic nationalism toward institutional loyalty to the smooth functioning of a globalized international financial architecture. The international finance architecture at this moment in history is dominated by dollar hegemony, which can be simply defined as a fiat dollars unjustified status as a global reserve currency. National banking then seeks insulation and independence from the international finance architecture dominated by dollar hegemony. The mandate of a national bank is to finance the sustainable development of the national economy, and its function aims to adjust the value of a nations currency to a level best suited for achieving that purpose within a regime of exchange control. On the other hand, the mandate of a modern-day central bank is to safeguard the value of a nations currency in a globalized financial market of no or minimal exchange control, by adjusting the national economy to sustain that narrow objective, through domestic fiscal austerity, economic recession and negative growth if necessary. International trade under central banking dominated by dollar hegemony becomes a race toward the bottom with beggar thy neighbor competition, rather than true comparative advantage. In response to dollar hegemony, PBoC has adopted a monetary policy stance in 2004 designed to rein in excessive money and credit growth, avoid excessive interest rates volatility and accelerate interest rate liberalization. Such a policy stance deals with the symptoms but not the causes of economic trends deemed undesirable by policymakers. Moreover, these policy objectives are cross-neutralizing on one another. The PBoC expects to keep M1 (currency in circulation plus the checkable deposits in depository institutions) and M2 (M2 includes M1 plus retail non-transaction time deposits) growth rate at around 17 for 2004, still a destabilizingly high rate when GDP (gross domestic product) growth is targeted to be less than 7. The outstanding yuan broad money, or M2, including money in circulation and all bank deposits, surged 19.1 year-on-year to 23.36 trillion yuan (2.8 trillion) by the end of April 2004, albeit the increase was slightly less than that of March. This M2 level is extraordinarily high in relation to Chinese GDP of 1.4 trillion, amounting to 200. The US M2 was 6.289 trillion in June 2004 against a GDP of 10.7 trillion, about 60. And the US money supply is considered excessive. Much of Chinas large M2 is caused by recent massive foreign exchange transmission of hot money. At the end of July, M2 was up by 20.7 from the same period last year, higher than the central banks planned growth of 17. Over the past two years, Chinas foreign-exchange reserves have grown rapidly, not from trade surpluses, but from the inflow of hot money. This has led to a substantial increase in yuan base money injection as a result of increased foreign exchange transmission. In line with its overall money and credit plan, the PBoC has attempted to prevent excessive growth of base money by withdrawing of yuan through open market operation. This has the effect of siphoning money from the domestic sectors to the export-related sectors where dollar hot money is concentrated. Since April 22, the PBoC has intensified currency withdrawal from circulation through issuing central bank bills. In 2003, base money injection as a result of foreign exchange transmission added up to 1.15 trillion yuan, while open market operation withdrew 269.4 billion yuan base money, resulting in a net base money injection of 876.5 billion yuan. By the end of 2003, the PBoC had made 63 issues of central bank bills, amounting to 722.68 billion yuan, leaving an outstanding additional currency amount of 337.68 billion yuan. The money withdrawal came from the domestic sectors and the injection went mostly to export and export-related sectors, including speculative real estate markets. The bulk of the yuan withdrawal went to foreign reserves holdings. This monetary exercise was essentially borrowing from the yuan economy to finance the rise in Chinas foreign reserves, which lent mostly to the dollar economy in the form of US Treasuries. The PBoC also aims to keep new bank lending for 2004 around 2.6 trillion yuan. Banks lent 835.1 billion yuan in new loans in the first quarter, representing 32 of the annual target and an increase of 24.7 billion yuan from a year ago. New loans by commercial banks between January and July soared to 1.9 trillion yuan, more than the 1.8 trillion yuan that they lent in all of 2002. But as banks are bypassed in the US by debt securitization in credit markets, Chinese banks are being bypassed by the age-old tradition of private loan syndication, which historically have been the financing of choice among overseas Chinese, when banks around the world routinely discriminated against immigrant Chinese borrowers and forced them to develop their own ethnic credit market. Macro measures have little effect on this growing informal Chinese domestic credit market, where interest rates can be higher than sub-prime credit-card rates in the US. The real problem is the absence of an effective national credit allocation policy. Central bank interest-rate liberalization works against a national credit allocation policy and allows the market to do the allocation. In unregulated credit markets, credit flows to borrowers willing to pay the highest interest cost, which usually means the highest-risk speculative ventures, rather than to where the national economy needs credit most. The PBoC claims that the ultimate objective of this monetary policy stance is to maintain balanced economic growth at a 7 rate target for 2004, holding consumer price index (CPI) around 3. With macroeconomic adjustment and regulatory measures, the hangover effect is expected to contribute 2.2 to CPI, with new inflation factors and price adjustment policies contributing 1. The main monetary policy instruments are open market operation, bank reserve requirement, interest-rate policy, re-lending and re-discount, and credit policy. The PBoC measures growth by GDP readings, as is common by international standards. Gross domestic product is a measure of national income. Dollar hegemony distorts GDP as a reliable index of growth for non-dollar economies since GDP includes foreign-reserves holdings when in effect such funds have left the local currency economy. Taking away annual rises in foreign-reserves holdings, real Chinese GDP is substantially lower than the 1.4 trillion figure. Take away also foreign-factor income in the form of returns on foreign capital, and real Chinese GDP may be half of what the misleading statistics show, since 54 of Chinas exports are traded by foreign investors. If one should ask to where has all the money gone given Chinas annual GDP growth of 9, the answer is that most of it went to the dollar economy. Moreover, this policy stance is in essence a neo-liberal supply-side approach. It is couched in typical policy jargon prevalent among central bankers, trapped by the flawed logic of the Washington Consensus and International Monetary Fund (IMF) snake-oil orthodoxy. The Chinese economy at this stage of its development does not need a tight monetary policy to fight overheating in some sectors any more than Chinese agriculture needs a drought to prevent soil-erosion from spring flood. What China needs is a new focused credit policy to shift from dependence on dollar-financed and - denominated export, and to institute full deployment of yuan sovereign credit insulated from dollar hegemony to finance the rapid development of its undeveloped domestic economy. It needs to dampen the overheated export sectors with administrative means and stop letting an unregulated international financial market direct national economic policy. China needs to stop exporting real wealth by reducing export of goods produced by low wages for useless fiat dollars and refocus on real growth of its domestic economy. China needs to free its currency from dollar hegemony and to stop letting the international credit market dictate national development. Wealth denominated in dollars has very limited use in China. It only forces the PBoC to inject yuan money supply into Chinas export sector so that China can finance US national debt with its dollar trade surplus. Financial comprador mentality is apparently dominating the policy establishment in the PBoC, which mistakes the size of its foreign reserves for national financial strength and confuses the health of the banking system under its regulatory supervision with the economic health of the nation. Chinas banks are basket cases only because China chooses to shift from a national banking regime to a central banking regime. Now the central bank wants to sacrifice the national economy to cure sick private commercial banks under its supervision, whose sickness ironically has been caused by a central banking regime. Under dollar hegemony, an economy that holds or needs to hold large foreign-exchange reserves in the form of dollars is a financially weak economy. The need for foreign reserves is clear evidence that the rest of the world has no confidence in that countrys currency and by extension, its domestic economy. The US, a global financial powerhouse, holds very little foreign currency. Japan and Germany, as defeated nations of World War II, have no option other than to be trapped in an international finance architecture dominated by dollar hegemony. It is a sign of serious poverty of insight, creativity and independent thought at the top that Chinas monetary establishment chooses voluntarily to play the same handicapped game as these two once-vanquished nations. At the same time, the PBoC has provided liquidity to support the privatization of financial institutions through flexible market operation. This liquidity is not used to finance national economic expansion, but to finance initial public offerings (IPOs) of privatized banks. Banks in a national banking regime are social institutions, but in a central banking regime, banks are private institutions. Privatization of social institutions is a dubious neo-liberal undertaking that requires close government supervision and regulation to justify. Central-bank-provided liquidity for the purpose of facilitating the privatization of state-owned banks takes on the form of legalized theft from the public. It provides public subsidy in the form of interest-free loans to the favored buyers of the privatized banks. At the end of August 2003, the IPO of Huaxia Bank led to substantial liquidity shortage in commercial banks. Under such a circumstance, the PBoC, on August 26 and September 2, 2003, twice reduced the issuance scale of three-month central bank bills and injected liquidity to commercial banks through seven-day reverse repo transactions. At the time of the Changjiang Power IPO on November 11, 2003, the PBC again conducted seven-day reserve repo transactions. Under the guidance of open market operation, the seven-day repo rate and typical inter-bank interest rates remained stable at around 2.15 despite liquidity volatility resulting from IPOs, which indicated that open market operation reached expected targets. Free money was handed over by the central bank to favored private borrowers to buy privatized state-owned assets. Given sufficient liquidity of financial institutions and falling trend of money market rates during the first quarter of 2004, the PBoC intensified sterilization operation, using open market operations to counteract the effects of exchange market intervention on the countrys monetary base. In this period, the cumulative amount of central bill issuance reached 435.2 billion yuan and outstanding amount stood at 615.45 billion yuan. Base money injection as a result of foreign exchange purchase amounted to 291.6 billion yuan, and open market operation withdrew 281 billion yuan, resulting in a net base money injection of 10.6 billion yuan and basically offsetting the foreign exchange position of base money. With fixed exchange rates, when excess foreign currency seeks to exchange into the home currency, as in the case of China in the past two years, the monetary authority must supply additional home currencies to keep the exchange rate fixed, even with controlled convertibility. The monetary authority buys up the excess foreign currency with local currency and increases its foreign exchange reserves. This operation increases the supply of home currency in private circulation. When a central bank intervenes to keep a fixed exchange rate, it needs to sterilize its foreign exchange intervention by taking separate actions to prevent the home money supply from rising or falling due to foreign exchange intervention. In the case of sterilization, the authorities will simultaneously buy or sell foreign currency and sell or buy interest-bearing domestic debt or assets to remove the excess or add depleted home currency, offsetting any effect on the home money supply. However, if the money supply stays unchanged, then according to the laws of open interest-rate parity, the monetary authority can keep the exchange rate fixed only by lowering domestic interest rates. Any excess supply of foreign currency that existed before will remain. It disappears only from the domestic money supply, and now reappears in the form of foreign-exchange reserves. The home interest rate will have to fall to offset pressure on the exchange rate to rise. Otherwise, inflow of hot money will continue. Thus the recent rise of the one-year benchmark interest rate by 27 basis points to 5.58, effective from October 29, 2004 - the first such hike in nine years - with the rise of one-year deposit rate to 2.25 from 1.98, is a counterproductive move in the context of managing hot-money inflow. The central bank also moved a step toward the goal of interest-rate liberalization, scrapping the upper limits on yuan lending rates. Banks can now charge as much as they want for yuan loans. The last time the PBoC raised lending rates was in July 1995, and the rates were last changed in February 2002, when they were lowered to boost a sluggish economy. These measures will only attract more inflow of hot dollars that had been caused by the gap between dollar interest rates and yuan interest rates to begin with. According to the principle of open interest-rate parity, if a monetary authority sterilizes, its ability to keep the exchange rate fixed depends on the markets aversion to exchange risk - an aversion ironically exacerbated by a fixed exchange rate not supported by a corresponding interest rate policy. Thus it is irrational for the PBoC to raise interest rates to cool the economy while the overheating was created by an inflow in hot foreign money due to high yuan interest rates. Those who advise the PBoC to raise yuan interest rates lack adequate understanding of the relationship between interest rates and foreign-exchange rates and the impact of hot foreign money on domestic money supply in a fixed exchange-rate regime. A central bank wanting to hold the exchange rate of its currency fixed against upward market pressure supplies domestic currency to the market, creating pressure for the nominal interest rate of the home currency to fall. This causes bonds prices to rise. A fall in the nominal interest rate spurs aggregate demand, which causes GDP and the price level of the economy to rise. This expansion of the economy - in particular, the rise in consumption and investment - may have been a completely unintended side effect of the central banks actions. A foreign-exchange intervention is said to be unsterilized if its effects are allowed to pass through to domestic inflation and domestic GDP, and is said to be sterilized if its effects are not allowed to pass through. A central bank sterilizes its foreign-exchange interventions with open-market operation following foreign-exchange intervention. The central banks desire to fix the domestic currency below market pressure leads to an expansion of domestic money supply, causing nominal interest rates to fall, which then spurs aggregate demand. If the central bank does not want to affect aggregate demand, then an open-market operation to maintain the nominal interest rate at its pre-intervention level is normally required. But there are alternative regulatory options, such as lifting bank reserve requirements, if the central bank does not want to change interest rates, albeit such alternatives are not without economic cost. The PBoC had elected to employ such alternatives until it succumbed to raising yuan interest rates in October. In order to rein in the obviously excessive credit growth, the PBoC had raised the required reserve ratio by 1 to 7 on September 21, 2003. The central bank raised the reserve requirement for commercial banks by half a percentage point to 7.5 effective April 25, 2004, and has called for banks, enterprises and local governments to help curb investments and cool down the economy. The new requirement applies to the countrys big four state-owned banks, 11 joint-stock banks and more than 100 urban and rural commercial banks. However, thousands of rural and urban credit cooperatives will maintain the existing 6 reserve requirement. Bank reserves are a percentage of total deposits that commercial banks must maintain for risk management. Only deposits over the minimum set by the central bank may be used for lending. The higher reserve will freeze approximately an additional 110 billion yuan (US13.3 billion) in commercial banks liquidity. The 0.5-percentage-point reserve hike is largely to prevent runaway growth of money and credit and keep the national economy expanding on a steady, fast and healthy track. Excessive credit growth could cause inflation, asset price bubbles, new non-performing loans at commercial banks and systemic financial risks. Financial institutions reserves at the central bank now exceed 2 trillion yuan. The China Banking Regulatory Commission (CBRC) has ordered banks to stop lending to steel, aluminum, cement, real estate and automobile industries. Calling on the reserve Conventional money and banking theories regard required reserve ratio hiked as a relatively drastic measure compared with changes in interest rates. Nevertheless, the PBoC interpreted it as a mild and preferred move. The reason is that the PBoC has to withdraw a large amount of excess liquidity because of fast growth of foreign-exchange reserves. To do so, if the central bank only issues CB bills without any other measure, it has to raise the interest rates on CB bills to a very high level given strong expansion momentum in the export sector and the commercial banks wide interest-rate differentials over the returns on CB bills. However, a high interest rate would have significant adverse implications on the whole economy. Moreover, it would exacerbate the inflow of hot foreign money. In contrast, the 1.5 rise of required reserve ratio enabled the central bank to reduce at a lower economic cost the commercial banks excess reserve by about 260 billion yuan, accounting for only 9 of their holdings of Treasury bills, financial bonds and CB bills. Therefore, the new required reserve ratio hike was considered a comparatively mild policy measure. The operative word is comparatively, for the measure was far from mild. Still, the policy was announced one month in advance, giving time for financial institutions to manage their liquidity. The PBoC also provided timely support to those financial institutions with short-term liquidity difficulties so as to maintain the overall stable development of financial operation and money market interest rates. Still, with each additional percentage point of reserve requirement tying down 260 billion yuan in excess reserves, a 7.5 reserve ratio translates into a reduction of more than 1 trillion yuan of bank loans, which may help achieve the new lending target for 2004 to around 2.6 trillion yuan, but it would not provide much help to the economy, particularly the depressed sectors. Since the overheating is concentrated mostly in export and export-related sectors of the economy, there is no compelling logic to reduce aggregate demand for the whole economy with a nationwide bank reserve ratio. But a larger question about the monetary effectiveness of bank reserve requirements needs to be addressed. Reserve requirements, a tool of monetary policy, are computed as percentages of deposits that banks must hold as vault cash or on deposit at a central bank. Reserve requirements represent a cost to the banking system. Bank reserves are used in the day-to-day implementation of monetary policy by the central bank. As of June, the reserve requirement for US banks was 10 on transaction deposits (checking and other accounts from which transfers can be made to third parties), and there were zero reserves required for time deposits. The US Monetary Control Act (MCA) of 1980 authorizes the Feds Board of Governors to impose a reserve requirement of from 8 to 14 on transaction deposits and of up to 9 on non-personal time deposits (those not held by an individual or sole proprietorship). The Fed may also impose a reserve requirement of any size on the amount depository institutions in the US owe, on a net basis, to their foreign affiliates or to other foreign banks. Under the MCA, the Fed may not impose reserve requirements against personal time deposits except in extraordinary circumstances, after consultation with Congress, and by the affirmative vote of at least five of the seven members of the Board of Governors. In order to lighten the reserve requirements on small banks, the MCA provided that the requirement in 1980 would be only 3 for the first 25 million of a banks transaction accounts, and that the figure would be adjusted annually by a factor equal to 80 of the percentage change in total transaction accounts in the US. An adjustment late in 2003 put the amount at 45.4 million. Similarly, the Garn-St Germain Act of 1982 provided for a 0 reserve requirement for the first 2 million of a banks deposits. This level, too, rises each year as deposits grow, but it is not adjusted for declines in deposits. For 2004, that level is 6.6 million. The transactions-account reserve requirement is applied to deposits over a two-week period: a banks average reserves over the period ending every other Wednesday must equal the required percentage of its average deposits in the two-week period ending the Monday sixteen days earlier. Banks receive credit in one two-week period for small amounts of excess reserves they hold in the previous period. Similarly, a small deficiency in one period may be made up with excess reserves in the following period. Banks that fail to meet their reserve requirements can be subject to financial penalties. Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10, for example, a bank that receives a 100 deposit may lend out 90 of that deposit. If the borrower then writes a check to someone who deposits the 90, the bank receiving that deposit can lend out 81. As the process continues, the banking system can expand the initial deposit of 100 into a maximum of 1,000 of money. In contrast, with a 20 reserve requirement, the banking system would be able to expand the initial 100 deposit into a maximum of 500. Thus, higher reserve requirements should result in reduced money creation by banks and, in turn, in reduced economic activity. In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest. Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money. Deposits that are components of M2 and M3 (but not M1), such as savings accounts and time deposits, have no reserve requirements and therefore can expand without regard to reserve levels. Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the US. Reserve requirements, the discount rate (the interest rate that Federal Reserve Banks charge depository institutions for short-term loans), and open market operations (buying and selling of government securities) are the Feds three main tools of monetary policy. There is a continual flow of reserves among banks, representing the ever-changing supply and demand for these reserves at individual banks. When the Fed engages in open market operations, it adds to or subtracts from the supply of reserves. The effectiveness of the Feds actions results from the reasonably predictable demand for reserves that is created by reserve requirements. The Fed changes reserve requirements for monetary policy purposes only infrequently. Reserve requirements impose a cost on the banks equal to the foregone interest on the amount by which required reserves exceed the reserves that banks would voluntarily hold in order to conduct their business, and the Fed has been hesitant to make changes that would increase that cost. There have been only a handful of policy-related reserve requirement changes since the MCA was passed in 1980. In March 1983, the Fed eliminated the reserve requirement on non-personal time deposits with maturities of 30 months or more, and in September 1983, it reduced that minimum maturity to 18 months. Then, in December 1990, the Fed cut the requirement on non-personal time deposits and on net Eurocurrency liabilities from 3 to 0. In April 1992, it cut the requirement on transaction deposits from 12 to 10. In announcing its December 1990 move, the Fed noted that the cut would reduce banks costs, providing added incentive to lend to creditworthy borrowers. Similarly, in announcing its April 1992 cut in reserve requirements, the Fed observed that the reduction would put banks in a better position to extend credit. Current reserve requirements are low by historical standards. From 1937 to 1958, the rate on demand deposits was always at least 20 for banks in New York and Chicago, which were central reserve cities - a term now obsolete. Before the passage of the MCA in 1980, only banks that were members of the Federal Reserve System had to meet the Feds reserve requirements. State-chartered banks that were not Federal Reserve members had to meet their states reserve requirements, which typically were lower. As a result, many banks dropped their Federal Reserve membership and member bank transaction deposits fell from nearly 85 of total US transaction deposits in the late 1950s to 65 two decades later, weakening the Feds ability to influence the money supply. The MCA sought to solve this problem by authorizing the Fed to set reserve requirements for all depository institutions, regardless of Fed membership status. The Fed has long advocated the payment of interest on the reserves that banks maintain at Federal Reserve Banks. Such a step would have to be approved by Congress, which traditionally has been opposed to this because of the revenue loss that would result to the US Treasury. Each year the Treasury receives the Feds revenue that is in excess of its expenses. The payment of interest on reserves would be an additional expense to the Fed. Apart from bank reserve requirement that is designed to insure liquidity, a private banks capital - also known as equity - is the margin by which creditors are covered if the banks assets were liquidated. A measure of a banks financial health is its capital/asset ratio, which is required to be above a prescribed minimum international standard set by the Bank of International Settlement (BIS), whose rules set requirements on two categories of capital, Tier 1 capital and Total capital. Tier 1 capital is the book value of its stock plus retained earnings. Tier 2 capital is loan-loss reserves plus subordinated debt. Total capital is the sum of Tier 1 and Tier 2 capital. Tier 1 capital must be at least 4 of total risk-weighted assets. Total capital must be at least 8 of total risk-weighted assets. When a bank creates a deposit to fund a loan, its assets and liabilities increase equally, with no increase in equity. That causes its capital ratio to drop. Thus the capital requirement limits the total amount of credit that a bank may issue. It is important to note that the capital requirement applies to assets while the bank reserve requirement applies to liabilities. The China Banking Regulatory Commission (CBRC) announced new regulations on capital adequacy on February 27 in a bid to enhance risk management of the banking sector in line with the BIS Basel Accord. After injecting 45 billion equity into two big state banks, Chinas foreign exchange reserves stood at 403.25 billion at the end of 2003. Under the stricter regulations, which took effect on March 1, capital adequacy ratios of Chinese commercial banks fell further below requirements. To give commercial banks more time to replenish their capital base, the CBRC has set the deadline for meeting the new requirements at January 1, 2007. Most of Chinas commercial banks fail to meet the 8 minimum requirement for capital adequacy even under the older rules, which has stood as a major obstacle hindering bank reform efforts. Chinese commercial banks are required to set aside part of their profits as bad loan provisions, but few of them have been able to meet that requirement. The vast amount of non-performing loans means, in some cases, that some banks have to set aside more money than the net profit they make. Under the new rules, the capital adequacy ratio - capital divided by risk-weighted assets - is calculated after a full deduction of bad loan provisions. Banks are required to fully set aside reserves only after 2005. The new rules end some favorable treatment in assigning risk weights to loans given to key state-owned enterprises and some types of mortgage loans. The rules allow the CBRC to give differentiated regulatory treatments to banks with different capital adequacy levels. The CBRC has the authority to take over or urge for restructuring of banks with seriously low capital adequacy ratios. The PBoC announced on March 25 that the required reserve ratio for financial institutions with capital adequacy ratio below a specific level would rise 0.5 to 7.5, while the ratio for other financial institutions remained unchanged. State-owned commercial banks, urban and rural credit cooperatives were exempt from the differentiated required reserve ratio policy. On April 11, the PBoC announced again that the required reserve ratio for all financial institutions except from urban and rural credit cooperatives (RCC) would rise 0.5 effective April 25. The differentiated required reserve ratio scheme was explained as both a transitional policy in line with Chinas current financial system and an innovation based on the original purpose of required reserve ratio policy, i. e. to ensure payment and settlement of commercial banks, and to prevent over-lending by financial institutions attracted to profitable loan terms which may undermine their liquidity and payment capacity. A period of one month is hardly a reasonable transition period for bank policy changes. The required reserve ratio policy then gradually evolved into a monetary policy instrument and the deposit insurance regime combined with supervision on capital adequacy ratio started to replace it as policy tools to impose prompt corrective actions on financial institutions based on different risk profiles. Given the fact that China has yet to establish a deposit insurance system and quite a number of financial institutions failed to reach the 8 capital adequacy ratio, the differentiated required reserve ratio scheme is conducive to curb excessive credit expansion of financial institutions with low capital adequacy ratio and poor asset quality, and to prevent the one-size-fits-all approach in macro financial adjustment and regulation. Yet a one-size-fits-all approach is basic to central banking standardization, an institutional flaw that central banks seek to correct with complex exceptions. At the same time, the PBoC aims to strengthen credit management by rigorously curbing loans to over-invested industries, and keeping the proportion of medium - and long-term loans at reasonable level. The PBoC will also endeavor to adjust loan structure, urge financial institutions to implement credit policy, promote financial ecological development, enhance re-lending and rediscount management, continue to improve and prioritize financial service to the rural economy, and further promote inter-bank market development. These are positive moves in support of national development, but hardly profit-driven market strategies for private banks. The priority of Chinas current interest rate policy is to enhance institutional reform so as to facilitate monetary policy transmission mechanism. This is a questionable priority unless institutional reform supports national economic development. A legitimate question centers on the validity of the assumption that a move toward market fundamentalism enhances national economic goals. The goal of all financial markets is to maximize private profit and in an unregulated market, private profit maximization often runs counter to national economic interests. Since September 2003, the year-on-year consumer price index (CPI) level has grown rapidly to 3.2 at the end of December, implying increasing inflation pressure. From January to March 2004, the CPI rose 3.2, 2.1, and 3.1 respectively and month-to-month rose 1.1, fell 0.2 and rose 0.3 respectively. The CPI in the first half of this year may continue to rise, but current one-year loan rate is 5.58, rising 27 basis points from 5.31 after nine years. If real loan rates should fall negative at some point in time, the behavior of market participants will be distorted. Already, firms can make profits simply by borrowing to acquire and hold inventory in certain overheated sectors, thus aggravating raw material shortage, pushing price level further up and leading funds to circulate in retailing rather than be invested in manufacturing. Therefore, the price level is one indicator the central bank must closely monitor when considering interest rate policy. Yet the Chinese economy is still highly disaggregated. Wide disparities in CPI readings are registered in different regions and economic sectors. This leads to the question about the validity of a unified national interest rate policy. Even in the US, where the economy is highly aggregated, the Federal Reserve System is comprised of 12 regional Federal Reserve Banks with 24 branches to monitor local economic conditions. In addition, the central bank is forced to take into account the destabilizing force of speculative foreign exchange arbitrage. Over the past two years, capital inflows have led to a substantial rise in Chinas foreign-exchange position. The amount of capital inflow is directly linked to domestic and foreign interest rate differentials. To deal with the problem, the PBoC adopted a floating re-lending rate regime. Re-lending refers to the loans central bank grants to financial institutions. Floating re-lending rate regime means the PBoC, according to macroeconomic and financial situations, can set and announce the extent by which the re-lending rates move above benchmark rates within the fluctuation band authorized by the State Council. Effective from March 25, the rates on one-year-or-less liquidity re-lending rose by 0.63 percentage point from existing benchmark level. In order to support agricultural development, floating re-lending rate regime for rural credit cooperatives (RCCs) will be implemented gradually over a period of three years, and three years later the rate increments for RCCs will be half of those for other financial institutions. The PBoC considers the adoption of a floating re-lending rate regime as another important step toward interest rate liberalization. It claims to help not only improve the interest-rate formation mechanism and the central banks capability of guiding market rates, but also upgrade the effectiveness and transparency of re-lending management. Such claims stretch monetary logic and policy credibility. Loan rate resetting Since January 1, the ways of resetting loan (excluding household mortgages) rates are being determined by borrowers and lenders through negotiation. The frequency of resetting rates on medium - and long-term yuan loans, previously once a year and now determined by borrowers and lenders, can be monthly, quarterly, annual, or fixed. This policy move has corrected the asymmetry between fixed deposit rates and annually changed loan rates. Consequently, commercial banks can determine the way of resetting loan rates according to customers credit rating, and flexibly design loan products. Also, shortened resetting intervals help commercial banks spot borrower solvency problems earlier. In addition, when the central bank changes benchmark rates, commercial banks can more promptly adjust loan rates based on lending agreements, thus mitigating interest rate risk, facilitating the transmission of monetary policy to manufacturing and consumption. The change of loan rates resetting policy forced commercial banks to establish offer system, to factor in credit risk and interest risk when estimating profits, and to set up internal transfer pricing mechanism. Yet often commercial banks fall into liquidity difficulties when the central bank abruptly and unexpectedly reverses interest rate trends. Since economic trends generally develop slowly, it would be reasonable to expect the central bank to make its interest rate calls with minimum element of surprise and with ample lead time. Yet central banks tend to play cat and mouse with the market on its monetary policy moves, making them major market-destabilizing agents. With the control of lending scale and deposit/lending rates, the commercial banks asset and liability management (ALM) only focuses on the ratio of deposit to lending. Interest rate liberalization, nevertheless, requires commercial banks to focus on interest rate risk and capital adequacy ratio. Loan rate floor management calls for commercial banks to adjust asset structure with risk pricing. According to a survey in 2002, less than half of outstanding commercial bank lending is at fixed rate, while in publicly traded commercial banks, the percentage of fixed rate loans is only 36. Since the 0.9-1.7-percentage-point floating range has basically liberalized lending rates, commercial banks now must learn to price risk. This is because China and Asia generally do not have a well-developed sovereign credit market providing long-term sovereign debt instruments as benchmark for bank loans and mortgages. Bank loan pricing then must take into account such complex factors as short-term fund cost, direct and indirect costs, loan taxation cost, loan maturity, loan risk and profit targets. Fund cost rate refers to the cost for commercial banks to obtain fund in the market with similar maturity and cash flows as the loan extended to clients, i. e. the internal transfer price of the loan. Direct costs, including all costs related to loan product and client services, can be derived from direct cost rate using activity-based-cost (ABC) or average-cost method. Indirect costs, generated from operations other than loan activities, can be calculated using the average-cost method. Because the calculation of direct and indirect costs both use historical data, the data must be updated regularly so as to ensure its effectiveness and applicability. In China, taxation cost rate is the operating tax rate plus added cost per loan. Credit risk premium is used to cover expected loan loss and the expected loan loss rate equals default rate multiplied by loan loss rate. To estimate loan loss, commercial banks must set up internal rating modes. The longer the loans maturity, the higher should be the lending rate. The logic behind is that longer maturity means longer financing period, consequently higher financing cost and greater possibility of changing cost. Therefore, the loan rates should rise accordingly. Profit targets can be estimated using return on capital and the ratio of capital to lending. At present, loan pricing is one weakness of Chinas commercial banks because of a history of interest rate control. In the process of interest rate liberalization in coming years, commercial banks need to step up efforts in pricing products, accumulate experience and develop basic data analysis to strengthen international competitiveness. But interest rate liberalization comes with an economic cost. The IMF has been rightly criticized for prioritizing the soundness of lending institutions over the health of borrowing economies by allowing interest payments to overwhelm the budget of many borrower governments. It is not a rational policy to destroy a national economy to save its adventuresome banking system, much less so a foreign adventuresome banking system. Deposit rate ceiling management requires commercial banks to actively adjust their liability scale and structure, and adapt themselves to capital adequacy ratio management. Commercial banking management theories have evolved from asset management, to liability management, finally to asset and liability management (ALM). Liability management for banks originated at the end of the 1960s, when high inflation and sharp and unexpected interest rate hike combined with rigorous interest rate control in many countries and led to disintermediation and fund shortage in commercial banks, forcing them to adopt liability management and to attract fund back into commercial banks through innovation. Bank liability management in China emerged from a very different history. The underdevelopment of capital markets and securitization of debt in credit markets have left banks as main intermediaries of credit in Asia generally and China in particular. In China, funds and risks are over-concentrated in banks while capital adequacy ratio of most commercial banks is low. To meet capital adequacy ratio requirements, commercial banks must reduce either asset or liability. With a deposit rate ceiling policy, commercial banks can tailor deposit price to specific situation. Commercial banks with low capital adequacy ratio can reduce deposit by lowering deposit rates so as to mitigate the pressure of excessively expanding loans to avoid loss due to large liability. Therefore, deposit rate ceiling policy not only helps rein in excessive credit growth and mitigate inflation pressure and non-performing loan risks, but also guide funds into capital market to promote capital market development and securitization. Yet savings do not disappear merely because bank deposit rates are low savings only seek other vehicles to achieve higher returns. With the underdevelopment of credit markets, an informal credit market emerges outside of control of the central banks. Both financial institutions and their customers need instruments to hedge interest rate risks in a liberalized interest rate regime. Option-pricing theory states that financial institutions, even without derivatives, can use basic instruments to create transactions with the same nature as derivatives to hedge risks. Derivative hedging is cost-effective and convenient. But its advantages to the hedging parties are derived from transfers of unit risk to systemic risk. The nature of derivative transaction requires high leverage, a risk reflected in the meltdown of major hedge funds such as LTCM. In this regard, China needs to enhance fundamentally the internal control of financial institutions before pushing toward derivative transactions to provide commercial banks and customers with hedging instruments. The era of 50 oil will greatly impact the global economy. Asia will be directly affected. With the Chinese economy overheated, rising oil price will exacerbate inflation pressures. Conventional wisdom suggests that this adds greater pressure on interest rate rise. China is the second largest oil consumer in the world after the US. Yet half the Chinese demand can be met with domestic oil products. The increased demand for imported oil comes from the expanding Chinese export sector. High oil prices cast a shadow over global growth prospects, which could dampen Chinese export growth and thus reduce Chinese demand for imported oil. But since a higher price of oil increases the income of oil producers and the expenditure of oil consumers for the same amount of oil, high oil price increases world GDP without expanding the world economy. High oil prices are inflationary on a global scale. Chinese export growth can transform into market share growth even as the global economy slows down. As Chinas global market share in export expands, the value-adding performance of its trade will correspondingly be upgraded even if global economic growth slows. High oil price has limited direct impact on Chinese domestic consumption since domestic consumption is supplied mostly by domestic production. So far, domestic inflation pressure has mainly come from food and farm produce prices. But oil prices are global. Chinese domestic oil will seek export markets if domestic prices stay below world market levels, unless price control is instituted. Rising prices in imported oil and oil products and other basic commodities affect mostly capital industries and the real estate sector. The manufacturing sector registered no inflation for lack of pricing power due to overcapacity, even though energy cost has increased. Cost-pushed inflation in the export sector has been largely neutralized by reduced profit margins and productivity increases from worker reduction and salary decreases. The high oil price has refocused the debate on the yuan exchange rate. An upward revaluation of the yuan may temporarily reduce the nominal cost of imported oil, but the resultant fall in the dollar will lead oil producers to further raise oil prices. The US has adopted a benign neglect posture on the falling dollar for devious reasons. And the chairman of the Fed actually began to talk down the dollar. The European Central Bank is caught in a dilemma. Since oil is denominated in dollars, a high euro will help the eurozone on energy cost and help contain euro inflation and keep euro interest rates low. As it is, all central banks are trying to keep short-term interest rate below neutrality because of high unemployment everywhere. A falling dollar will also reduce windfall profits for the Organization of Petroleum Exporting Countries. The US will keep oil around 50, which is good for oil-producing states such as Texas keep the Europeans quiet about a falling dollar, increase US exports to keep the labor unions under control, defuse mounting isolationism in Congress and make it cheaper to foreigners to invest in dollar assets, keeping dollar asset prices up. There is no incentive for Washington to alleviate international tension if that will bring the dollar up. Thus the monetary argument for multilateralism is also disarmed. China has an unbalanced, overheated economy, with some serious over-investment in some sectors and regions while other sectors and regions are caught in protracted stagnation and credit crunch. The key to the Chinese economy lies in rebalancing export with domestic development and shifting investment from overheated regions to depressed underdeveloped regions. This shift requires policy planning to rein in unregulated markets and to apply national banking principles to domestic development. Doctrinaire central banking in support of capital markets for maximum return on capital at the expense of national development must be curbed. Improved risk-management systems alone will not cure the problem of excess liquidity pouring into unauthorized steel mills, aluminum smelters and real-estate projects, causing an inflationary investment bubble. Planned credit allocation needs to be strengthened in keeping with the Five-Year Plan, which has been largely ignored by blind faith in market fundamentalism. China had 139,400 building projects under construction in the first seven months of 2004, with total investment rising 38 to 11.2 trillion yuan, most of which were located in over-saturated markets in overheated regions. No amount of bank risk management can withstand such massive scale of credit-market failure. Give credit where due Credit allocation is not related to the level of interest rates in a planned economy. In the US, credit allocation is handled with tax deductibility of interest payment in government-encouraged sectors. Much of the credit misallocation in China has been created by its state privatization policy to rely on a market economy for economic growth. This unleashes massive off-budget spending financed with loans from newly privatized banks based on unrealistic revenue projections. Such privatization activities have contributed to the concentrated surge in domestic loan demand in saturated markets. When economic growth slows, these loans will turn non-performing. The overheating in the Chinese economy is concentrated along the coastal region, with the rest of the nation left underdeveloped for lack of credit. It is also concentrated in proliferation of copycat projects of earlier entrepreneurial successes. The Chinese Ministry of Finance had announced that starting October 1, 1999, interest payment to bank depositors would be taxed at an annual rate of 20 nationwide. This action ended four decades of tax-free interest income. It defies common sense for Xinqiang to have the same interest tax rate as Shanghai if the government promotes a policy to shift investment to the interior west. Chinas total tax revenue is less than 12 of GDP, one of the lowest in the world. This is the residual legacy of a socialist economy in which tax revenue is not crucial for financing public expenditure. The use of sovereign credit for domestic development is conditioned on the principle of the State Theory of Money, which asserts that the value of a fiat currency rests on government authority to tax. In shifting to a socialist market economy, China is under-taxed for the full application of sovereign credit for domestic development. This fact limits the ability of the central government to plan for balanced national development. And the Chinese economy is still highly disaggregated by location. Unlike the US, where the states enjoy substantial power to set local tax policies to compete for growth, Chinese provinces are allotted very limited autonomous authority in this regard. Thus the depressed, low-growth regions constantly find themselves at a disadvantaged competitive position compared to the coastal, developed ones. Higher interest rates across the whole economy affect not only overheated sectors and regions, but also underperforming sectors and regions. Chinas agriculture and service industries have received less investment compared with natural resource sectors closely related to the export sector and the real estate sector in coastal cities. While fixed-asset investments grew 40, year-on-year during the years first quarter, investments in the nations agriculture sector rose a scanty 0.4. Chinas service sector has not shown any sign of overheating. In fact, education and health services have experienced declining investment for more than two decades. Since private investments are expected by policy to gradually replace government spending as the economys main driving force, high interest rates will cause credit crunches on fund-strapped sectors while having little influence on already-overheated sectors. Chinas policymakers have been unduly and unwisely influenced by Hong Kong capitalists whose experience has been limited to real estate and light manufacturing and have not the slightest clue on national economic development policy. By the end of June, bank loans to the real-estate sector reached 2.1 trillion yuan, up 36.1 year-on-year. New investments in land developments increased 28.7. A recent field survey by the National Bureau of Statistics indicated the average property price in 35 of Chinas cities increased 10.4 in the years second quarter compared with a year ago. In Shanghai, the growth figure reached an astonishing 20. In industries supporting real estate construction such as steel, cement and building supplies, fixed investment is as high as 172 (iron and steel). Official government estimates say that when all steel projects currently under construction come to full production, they will turn out more steel in 2005 than the country will be able to use until 2010. Despite the central government tightening regulations in the steel, cement and aluminum sectors, the real estate sector drove steel prices up 2.1 in July from June, and 18 from a year ago. The price of cement rose 4.7 from June, and 11.6 year-on-year. The PBoC noted in its 2004 third-quarterly report on monetary policy that its credit-tightening measures have prevented new investments in the real-estate sector, but failed to influence the demand side. As investments and new projects in land development continue to decline, demand will consequently exceed supply. This will push property prices up. But the demand side in the real estate sector can be managed in ways besides interest rate hikes, such as increasing down payment ratio for residential mortgages to effectively bring down property prices. But the real factor behind price inflation in real estate is not construction cost, but rising land cost, a factor over which the central bank commands no direct control. Investments in real estate grew by more than 40 in the first quarter year-on-year. This is the fastest growth in Chinas modern history - almost three times the 25-year average of 15. What this means is that investors are pouring money into real estate, which is jacking up prices and creating an artificial bubble just waiting to pop. Figures from the end of 2003 estimate that real-estate vacancies stand at 26, quadruple the US figure, eight times Hong Kongs and two and a half times the international norm. The inventory cannot possibly be absorbed by domestic consumers whose income cannot support such speculative prices. These prices are sustained by speculative momentum. Yet the recent interest rate hikes in the US are unlikely to cause an outflow of speculative funds, or hot money, from China. Martin Feldstein, president of the National Bureau of Economic Research and Harvard professor of economics, has calculated that a 0.25 or even a 1 increase in dollar interest rate will not make hot money leave China. This is because Chinas rigid currency regime and tight control over capital accounts means speculative funds will, over the short term, have trouble finding a way to benefit from the abrupt rate rises in the US. A short-term rate change would not affect foreign direct investments (FDI) going into China as FDI is generally for the long term. On the other hand, a widely expected US long-term policy of a measured pace of interest rate hikes will force interest rates in other currencies to rise. Chinas GDP still grew 9.8 in the first quarter of 2004. Fixed asset investment reached 879.9 billion yuan, up 43 year-on-year. The April consumer price index (CPI) also jumped to 3.8, compared with 2.8 for the first quarter. Money supply in the first quarter grew 17 and new loans reached 2.6 trillion yuan, the second highest in history. Yet amid these bullish growth data, unemployment keeps rising. Also in April, construction of a major steel smelting facility in Jiangsu province was brought to a screeching halt for alleged illegal land expropriation and improper borrowing. The move was widely viewed as part of the effort to halt undesirable construction in an overheated sector. The State Development and Reform Commission also conducted a nationwide price inspection. Local governments were instructed to halt utility price hikes if inflation in their areas exceeded national norms. Financial institutions lent 1.88 trillion yuan in the first seven months of 2004, already topping the total for loans in 2002. Interest rates have soared after the release of these data. The rate on benchmark seven-day repurchase agreements jumped to above 2.8, even higher than the 2.66 coupon on a seven-year sovereign bond issue earlier in 2004. The problem is that these loans have been made in the wrong sectors and to the wrong borrowers. PBoC has already reversed a contractive stance it maintained for the first eight months of 2004 in open market operations, releasing 35 billion yuan of currency in repurchase agreements in September. The CPI is expected to rise less than 1. The auto and real estate sectors, where prices have been growing the fastest, are currently not factored in Chinas CPI. Both sectors appear to be heading for abrupt slowdowns due to dwindling purchasing power. And the ex-factory prices for consumer goods, which largely dictate CPI trends, have been on the decline in 2004. The CPI, after months of decline, started to rise in October 2003, hitting 1 in April, but subsided afterwards. It registered 0.5 rise in August 2004. Little noticed is that fact the CPI declines often comes from declining corporate profits. The growing investments are partly the result of years of low investment, fueled by heavy initial investments in such sectors as automobiles, and may be offset by the sluggishness in spending. Since August, Chinas macroeconomic policy makers have faced a dilemma: either fail in cooling down the economy or risk causing economic depression. The official jobless rate is 4.3 that does not reflect the real situation since it does not include laid-off workers from state-owned industries or migrant workers. Even though Chinese workers earn on average 0.61 an hour, China is losing manufacturing jobs because of technological advances as employers try to boost productivity by laying off redundant workers, given that wages cannot fall below zero. Unskilled workers can become cost-ineffective against the cost of automation. Evidence is mounting that job shrinkage can also occur on low wage levels in a booming economy. Fixed-asset investment in China rose 26.3 year-on-year in August 2004, down from 31.1 in July and far below the 47.8 in the first quarter. Other key data shows a similar trend. Industrial output rose 15.9 year-on-year, slightly above a 15.5 rise the month before but well below the 19.4 first-quarter growth rate. M2 money growth hit a 3 1/2-year low in September, growing 13.6. Household savings deposits grew 14.9 in the month, considerably down from a January peak of 20.5. The Asian Development Bank forecasts a 13 increase in domestic consumption in 2005 as urban and rural incomes keep rising. Signs that inflation has peaked, growing 5.3 in August - unchanged from July - were also welcomed by economists. It was the first time since February that price rises have not accelerated. Thus while growth is still at a high rate, the trend has slowed. Concern is now shifting from fear of a hard landing to concern that growth will soon accelerate again as the restrictive measures gradually lose their initial impact. The corporate sector can work its way around administrative measures as they draw from their past experience at evading them. Continued foreign direct investment, rising inflation and anecdotal information on distribution bottlenecks suggest that the economy is not cooling down, at least in the intended sectors. The last thing the Chinese economy needs now is a slow down in consumer spending while capital spending continues. Chinas new rural cooperative medical system has benefited more than 95 million people since it was implemented last year. Still, that amounts only to less than 1 of Chinas rural population. The new system is mainly used to help farmers who are impoverished by illness and to reimburse costly treatment and hospitalization expenses. The funds come from the central government budget, local government subsidies and farmers tax payments. By the end of September, the funds amounted to three billion yuan, which translates into 3.50 per capita benefit recipient. The new system is expected to cover all the countrys rural areas by 2010. With threatening over-investments, the PBoC warned that it could inflame inflation or asset price bubble, resulting in new non-performing loans and financial risks, those financial risks being mass bankruptcies as the result of market oversupply. Much of this excessive investment is going into blind investment and duplicate construction, which pose the same risks. Blind investment finds banks and independent investors throwing money at some projects or industries without any risk assessment, or just following the herd instinct into a booming, but potentially disastrous, market. Duplicate construction means jumping on some bandwagon and over-investing in industries already saturated. For example, the Zhujiang area in Guangdong has eight airports in a region the size of Massachusetts and Connecticut. In addition, local governments fall all over each other to establish special economic zones, but 43 of the land in such zones remains unused, with no revenue to service the loans spent to build the enabling infrastructure. Curbing bank lending and reining in bad and redundant investments do not address the structural causes that have led to these problems. In 1993, similar measures led to a severe recession, deflation and insolvent banks. Yet market forces have become stronger in the Chinese economy now than in 1993 and the rate and scale of investment are much greater today because of hot money inflow. For example, profits on investments in the steel industry increased by more than 100 year-on-year in the first two months of 2004. By calculating Chinas trade revenue against its total foreign reserves, the amount of hot money flowing into the country in the first quarter this year may amount to as much as 30.9 billion, or an increase of 25.6 over last year, when Chinas foreign reserves increased by 57. The central bank needs to sterilize foreign exchange reserves by selling treasury bonds and to sell more treasury bonds, it will have to raise interest rates. This only encourages more hot money as speculators change their dollars to yuan in anticipation of a revaluation, collecting higher interest rates until they can sell back their yuan at a profit. Meanwhile, Chinas economy continues to overheat with over-investment in saturated export sectors, while inflation ravages other under-invested domestic sectors. Administratively, the government has done all it can do within the limits of a market economy and the economy is still overheating. The loan curb, the projects halts, the rise in bank reserve requirement and the interest rate rise have not reduced overheating in the export sectors, but have created mounting stress in the domestic sectors. It has been suggested that a 10-15 revaluation of the yuan would take speculative pressure off the currency immediately, and foreign money coming into the country to invest in overheated industries would slow overnight because speculators would get fewer yuan for their dollar. At the same time, such a revaluation would restore flexibility in managing both fiscal and monetary policy, enabling policymakers to raise interest rates without consequences on hot money flow. But high interest rate will cause an immediate burst of the ongoing hot money bubble, making the cure worse than the disease. Some have suggested that the yuan should be removed from its peg to the dollar and repegged to a currency basket weighted on the currencies of Chinas major trading partners. This would supposedly maintain the equilibrium value of the yuan in a dynamic global economy. Once the yuan is re-pegged, and a new reference basket implemented, any additional moves, such as widening the trading band, could be phased in during a transition period of some years. This would supposedly provide a safe and effective path to a more flexible exchange rate regime. But dollar hegemony renders such scheme inoperative. The exchange value of the yuan is only the symptom and not the cause of the problem. The problem is that under dollar hegemony, trade surplus ships wealth to the dollar economy in the form of added dollar reserves and trade deficits ship wealth to the dollar economy in the form of dollar debts. Either way, exporting for dollar is a losing game for the non-dollar exporting economies. To guard against possible risks, Chinese regulators have launched a probe into foreign exchange acceptance and settlement operations by commercial banks. The State Administration of Foreign Exchange (SAFE) said it would clamp down on illegal cross-border capital flows. An effective mechanism to more closely monitor the flow of speculative capital in and out of the country is urgently needed. For more than 18 months, speculators both inside and outside China have been betting that the yuan will appreciate sharply against the US dollar. But a significant appreciation now appears less likely. The constellation of forces that made yuan appreciation appears unavoidable have now shifted their alignment. Chinas current account is in deficit so far this year and rising, suggesting that from a trade competitiveness perspective, the yuan is not undervalued on a global basis. The yuan is not even undervalued to the dollar since much of the US current account deficit is a structural component of dollar hegemony, not just an overvalued currency. In addition, much of what China wants to buy from the US, particularly high-tech products, is banned from sale by US policy. Yet a rise in yuan interest rate was also considered unlikely until it surprisingly became reality. The changing dynamics surrounding inflow of hot money is a big part of total capital inflow. Chinas capital inflows are different from those suffered by South-East Asian stock markets in the run-up to the financial crisis of 1997. The speculative funds entering China have not been destined for domestic stock markets but rather for the construction and real estate sectors. Since April, China has issued a series of administrative orders to cool down construction and property investments. Some projects have been stopped and others have found bank financing drying up. The cumulative effect has been that hot money is finding it increasingly difficult to find profitable projects. Hot money inflows have averaged between 10 billion to 13 billion a month this year. This, in turn, could mean that Chinas foreign currency reserves may start to expand less quickly month after month. This trend may convince speculators that pressures on the yuan to revalue are dissipating. A slowdown in the growth of Chinas foreign reserves means that China will be buying less US debts, creating problem for the US debt bubble and causing dollar interest rates to rise, thus reducing dollar hot money from leaving the US. A sustained drop in foreign central bank purchases of US debts could add to pressures on the US Federal Reserve to raise interest rates at a faster pace. That could support the US dollars value against other currencies, thereby bringing the yuan up with it. But high dollar interest rate can abort the anemic recovery of the US economy. The alternative facing the Fed is that it will have no option except to inject more liquidity into the dollar money supply, by keeping dollar interest rates below neutral, accepting inflation as growth. Some of the excess dollar liquidity will find its way into China as hot money. Central bank officials have repeatedly said that China will continue to lift foreign exchange control to balance trade and gradually make the yuan a freely convertible currency. The floating of yuan exchange rate was an objective set at the Third Plenary Session of the Fourteenth Central Committee of the Communist Party of China in 1993, more than a decade ago. But the process is expected to take a relatively long time. China has already taken a series of measures to make exchange under current account easier and to liberalize restrictions on capital account transactions. However, trade liberalization, removal of excessive restrictions on capital account transactions and reform of state-owned commercial banks need to be accomplished before adequate flexibility can be introduced in the exchange rate regime. The difficulties and destabilizing effects of these moves tend to justify even more gradualism. The last thing China needs is to repeat Russias disastrous shock-treatment market liberalization, from which the former superpower never recovered. Nothing to gain As foreign-funded financial institutions will be permitted under the terms of the World Trade Organization (WTO) to conduct yuan business and substantially broaden their market access in China by 2006, Chinese state-owned commercial banks need time to strengthen their competitiveness and risk-prevention mechanism to viably response to a new exchange rate regime. The prospect of Chinese commercial banks being ready for international competition within two years is almost zero. On the other hand, the prospect of a global financial crisis caused by dollar hegemony before 2006 is very high. Those within the Chinese policy establishment who opposed Chinas entry into WTO may have their warnings vindicated. With the global financial system on the verge of collapse, isolationism is not an extremist position. If an adjustment of the yuan exchange rate makes Chinas staple agricultural products uncompetitive with imports, farmers, especially those in the coastal regions, will be forced to migrate to cities in a much higher rate, making non-farm employment demand more acute in cities. A one-percentage-point fall in agricultural employment translates to a need of 4 million additional non-farm jobs. The head of the PBoC has said that given the size and development stage of China economy, the prevailing exchange rate regime has been working quite well. Between 1994 and 1997, the exchange rate of the yuan against the dollar appreciated from 8.7 to 8.3, reflecting a managed float regime. At the end of 1997, at the request of neighboring economies and international institutions, China substantially narrowed the floating band of the yuan exchange rate to help reduce the shock of the Asian financial crisis and dispel the fear of yuan devaluation. Yet, the central banks view is that with the role of the market becoming increasingly important in the Chinese economy, the exchange rate of the yuan will increasingly be determined by market forces. Although it was not expected that China would respond automatically to the recent dollar interest rate hikes, the PBoC did raise interest rate amid concerns about rising prices. On September 15, 2003, the Chinese government issued 2.4 billion yuan of sovereign debt. China has adopted aggressive financial policies over the past five years to alleviate deflationary and unemployment pressures. This has led to a sizable fiscal deficit that must be made up for by issuing sovereign debt. Last year, China issued a total of 592.9 billion yuan of sovereign debt. According to official Chinese estimates, this year will see the issue of 637.6 billion yuan of sovereign debt. Increasing market interest rates will lead to a fall in price of sovereign debt, which will be disadvantageous to the issue of sovereign debt to make up for huge budget deficits. This will make aggressively tight monetary policies difficult. China wishes to maintain a fixed exchange rate in order to maintain export competitiveness and avoid deflation, but is doing so by creating a sharp increase in the issue of money, which may lead to an overheated bubble economy, increasing the amount of non-performing loans and systemic financial risk. China therefore wants to tighten money supply by slowing the rate at which money is issued and suppressing inflation. However, this may in turn lead to higher interest rates and increase the cost of monetary policy implementation, while at the same time possibly increasing the rate at which speculative hot money enters the country, thereby increasing the pressure on the yuan to appreciate. Higher interest rates will lead to falling consumption and investment across the entire economy, which will further aggravate Chinas still very serious deflationary problem in key domestic sectors. The government must therefore actively increase fiscal expenditure. Such is the difficult dilemma currently faced by Chinese policymakers. China has posted price increases for some industrial goods while others have been leveling off. Declining steel prices as a result of oversupply are especially a concern. Overall, prices of industrial goods leaving the factory, measured by the producer price index (PPI), edged up 0.7 in April 2004 over March and rose 9.3 over the same month a year earlier. Prices for most basic commodities such as food, minerals and fuel continued to rise, while those for consumer goods like television, washing machine and refrigerator fell. Propped up by food and raw material price increases, Chinas consumer price index rose a modest 2.8 year-on-year from January to March. The Chinese government has set a 3 CPI increase target for 2004 and the central bank predicted that the index would continue to climb after April because of the spill-over factor and a lower comparative base from the same 2003 period, when the Chinese economy was hit by the SARS outbreak, but the CPI is expected to fall starting from the third quarter. Nationwide investment in fixed assets, including capital projects and factory equipment, soared an annualized 43 in the first quarter, which the central bank blamed partly on some departments and local governments neglecting central government calls and keeping investment robust to score political points. Banks loaned 835.1 billion yuan in the first quarter, representing 32 of the annual target and an increase of 24.7 billion yuan from a year ago. The outstanding broad money, or M2, including money in circulation and all deposits, surged 19.1 year-on-year to 23.36 trillion yuan by the end of April. The increase was almost equal to that of March. By tightening the monetary policy, the central bank said its annual targets - letting both M2 and M1 grow 17 and commercial banks lending add 2.6 trillion yuan - could be reached. It said the impact of its policy initiatives such as higher bank reserve requirement and open market operations, including issue of central bank bills and treasury bonds trade - would be felt later. To brake the economy is not the task confined to the central bank. The State Development and Reform Commission recently issued a regulation on controlling rush investments and clearing away copycat projects the ministry of land and resources recovered more than half of Chinas 6,015 development zones last year and has stopped approving new such zones. The international pressure to revalue the yuan is becoming more an issue of political concern than of economic significance. Chinas agriculture and service industries have received less investment compared with sectors related to natural resources and the industries closely associated with the real estate sector. While fixed-asset investments grew 40 year-on-year during the first quarter, investments in agriculture rose only 0.4. Chinas service sector has not shown any sign of overheating. By the end of June, bank loans to the real estate sector had reached 2.1 trillion yuan, up 36.1 year-on-year. New investments in land development increased 28.7. A recent field survey by the National Bureau of Statistics indicated the average property price in 35 of Chinas cities increased 10.4 in the second quarter compared with a year ago. In Shanghai, the growth figure reached an astonishing 20. In July, steel prices rose 2.1 from June, up 18 from a year ago. Price of cement rose 4.7 from June, and 11.6 year-on-year. With inflation on the rise, China is quickly slipping into negative interest rates. A negative interest rate over a long period would inevitably deter people from putting their money into banks. In the second quarter, only 32.2 of those surveyed have recently chosen to put more savings in banks, 2.5 and 1.1 percentage points lower than the figures in the first quarter this year and the same period last year. Many people chose to invest in financial assets other than bank deposits. Investment funds served as a main channel for diversified household savings. In the first half of this year, net value of investment funds increased 132.4 billion yuan, 126.8 billion yuan more than the same period last year. A rebound in the stock market, especially in the first four months of this year, has amplified the diversion of funds from personal bank accounts. As of the end of July, 71.57 million folks had investment accounts in Chinas two stock exchanges, in Shanghai and Shenzhen, 1.86 million more than the same period last year. In the first half of this year, domestic stock investment amounted to 35.6 billion yuan, 11.4 billion yuan more than a year ago. A higher interest rate on treasury bonds compared to bank deposits also lured investors. In the first six months of the year, the ministry of finance issued five certificate treasury bonds with a total household investment of 122.7 billion yuan, 114.3 billion yuan more than the same period last year. Investment in insurance also diverted household savings, with investment volume in life insurance hitting 178.8 billion yuan within the first six months, 11 billion yuan more than the figure in the first half 2003. Altogether, household investment in stocks, funds, treasury and enterprise bonds, and insurance totaled 482 billion yuan in the first half, 262.6 billion yuan more, or 1.2 times the figure, compared to the same period last year. Increased consumption also contributed to the drop in household savings. Sputtering increases of demand has been a prominent problem in the Chinese economy in recent years. This year, total retail sales increased 2.95 trillion yuan in the first seven months, a year-on-year increase of 12.8. Deducting price factors, the increase was 4.5 percentage points higher than that of the same period of 2003. There is generally an inverse relationship between consumer spending and household savings. For a given supply of money, an increase in the production of goods will increase the exchange value of a currency since each unit will buy more goods. Likewise, increasing the supply of money relative to a fixed output of goods will lead to a decline in the purchasing power of money with each currency unit buying fewer goods. Given the relatively high rate of growth in Chinas money supply, there could be considerable pressures for the yuan to depreciate. This is because a rate of growth of the money supply that exceeds the growth rate of economic activity tends to cause the rate of exchange to fall. Even if exchange rates are fixed but capital can move freely, capital flight from the country tends to put pressures to end loose monetary policies. When exchange rates are determined by supply and demand, imbalances can continue for a long time only if most central banks coordinate their policy stances. Once they stop following similar monetary policies, the exchange value of a currency can drop sharply. In the worst case, the collapse of the exchange rate can trigger a severe shock to the real side of the domestic economy. What is happening with respect to international valuations of the dollar at the moment is that US central bankers are pumping dollars into the dollar economy to finance US trade deficits. That forces US trading partners to pump local currencies in their economies through foreign reserves transmission. But the additional dollars is recycled into dollar debts and stay in the dollar economy. Thus the dollar economy grows faster than the US economy. So the dollar will continue to weaken as long as the rate of increase in new dollars into the dollar economy is greater than the growth of the US economy. Dollar hegemony prevents non-dollar central banks from pumping more local currencies into the economy. Under such conditions, equilibrium between the dollar economy and the US economy can only be maintained with the continued fall of the exchanged value of the dollar. What China needs to do is to raise wages, not interest rates, to increase consumer spending. It is of course plausible that at some point spending could outgrow the economys capacity to produce, causing prices to accelerate to unacceptable levels. Economists have labeled the unemployment rate below which this inflationary spiral would theoretically ignite as the NAIRU, or the non-accelerating-inflation rate of unemployment. In the early 1990s, the conventional wisdom among economists, including most at the Federal Reserve, was that the unemployment rate could not go below 6 without triggering an accelerating rate of inflation. The few economists who pointed out that there was little empirical evidence to support this theory and that the economy could achieve non-inflationary unemployment rates of 4 or even lower were derided by the profession and ignored by the business media. The US unemployment rate has now been below 6 since September 1994, below 5 since June 1997, and below 4.5 since April 1998. Core inflation has not only not accelerated, it remains dormant. The NAIRU is revealed as useless as a guide to economic policy. Every episode of accelerating inflation in the US since 1960 was led by prices, not by wages. The current effort to slow down the Chinese economy, therefore, appears to be targeted at weakening the bargaining position of labor against capital. Throughout the economic expansion of last decade, wages have fallen behind corporate profits in every economy of the world, including China and the US. In the US, economist Jared Bernstein has calculated that even if labor costs were to accelerate to rising 1 faster than productivity, it would take four years before wages and profits went back to their respective shares in the decade of the 1980s. In moving toward a socialist market economy, China can benefit from lessons learned in the US New Deal. The National Industrial Recovery Act aimed to stabilize industrial prices, raise wages and promote collective bargaining, while the Agriculture Adjustment Act aimed to raise farm prices. These measures were combined with measures for reforming banking and financial practices and increasing the supply of money and credit. The New Deal also appropriated large sums for direct relief for the poor and the unemployed and for a massive public works program. Unfortunately, both acts were struck down by a conservative Supreme Court as unconstitutional, which fortunately is not a problem for China. But to do that, China must first insulate its currency from dollar hegemony and relieve its economic growth from excessive dependence on export for dollars.