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### Viewing cable 09BEIJING728, PREMIER WEN'S COMMENTS ON U.S. TREASURIES: PROTECT

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
09BEIJING728 | 2009-03-20 11:11 | 2010-12-26 21:09 | CONFIDENTIAL | Embassy Beijing

`

    VZCZCXRO5318
    OO RUEHCN RUEHGH RUEHVC
    DE RUEHBJ #0728/01 0791110
    ZNY CCCCC ZZH
    O 201110Z MAR 09
    FM AMEMBASSY BEIJING
    TO RUEHC/SECSTATE WASHDC IMMEDIATE 2993
    INFO RUEHOO/CHINA POSTS COLLECTIVE PRIORITY
    RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
    RHEHNSC/NSC WASHDC PRIORITY

` `

    C O N F I D E N T I A L SECTION 01 OF 03 BEIJING 000728

    SIPDIS

    STATE FOR E, EAP, EAP/CM, S/P
    TREASURY FOR OASIA/DOHNER/WINSHIP
    NSC FOR LOI

    E.O. 12958: DECL: 03/20/2034
    TAGS: ECON EFIN PREL PGOV CH
    SUBJECT: PREMIER WEN'S COMMENTS ON U.S. TREASURIES: PROTECT
    CHINA'S INVESTMENTS

    REF: BEIJING 0666

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

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

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

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

    Stabilize the Economy, and Protect the Investors
    --------------------------------------------- ---
    ¶4. (C) In a March 19 follow-up conversation with Finatt, SAFE
    DG Yin, who clearly had deferred meeting with us until he
    received approval and guidance from his superiors, said the
    Premier had been "worrying" about all of China's investments
    in the U.S., including U.S. Treasury securities. Wen also
    had "noticed" the policies promulgated by the administration
    of President Obama, and hoped that the measures taken to
    address the global economic crisis would help to stabilize
    the financial systems and promote economic recovery. Yin
    also said his "understanding" of Premier Wen's message was,
    in addition to the above objectives, that U.S. policy should

    BEIJING 00000728 002 OF 003

    focus on protecting the interests of investors, as both
    financial stability and protecting investor rights were
    important for strengthening the confidence of domestic and
    foreign investors.

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

    Huge Internal Debate
    --------------------
    ¶6. (C) Other Chinese contacts have offered us similar
    versions of their Government's concerns about its U.S.
    investments in recent weeks. In a February 27 meeting with
    visiting Treasury DAS Dohner, senior economist Shen Minggao
    of the respected "Caijing" magazine said there has been a
    "huge debate" within the government about China's holdings of
    U.S. Treasuries. Some officials are concerned about the
    risks of future U.S. inflation due to excess liquidity
    creation and USD depreciation. Furthermore, if China buys
    more, the risk grows. He understood that SAFE has been
    shifting its portfolio toward shorter-term assets to reduce
    the risk of capital losses from higher inflation. Shen also
    recommended the USG consider entering a bilateral agreement
    with China under which China would continue providing funds
    to the U.S. in exchange for some sort of hedging scheme.

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

    Comment
    -------
    ¶8. (C) Regarding Premier Wen's remarks at the NPC press
    conference, comments of this nature by senior Chinese
    leaders, both public and private, are not new, although they
    have not been expressed so directly at such a senior level.
    Last fall on numerous occasions, Vice Premier Wang Qishan
    remarked to then-Secretary Paulson, both privately and during
    the public session of the Strategic Economic Dialogue, on the
    need to "protect" Chinese investments. Since then, officials
    from SAFE have repeatedly noted concerns about the risks of
    an adverse market reaction, in both the fixed income and
    foreign currency markets, to upcoming large gross issuances
    of U.S. Government securities and the Federal Reserve's
    injections of liquidity. (Comment: the U.S. dollar dropped
    significantly against major currencies following the Federal
    Reserve's announcement that it would be increasing

    BEIJING 00000728 003 OF 003

    significantly its purchases of various U.S. fixed income
    instruments, including long-term U.S. Treasury bonds).

    ¶9. (C) Comments of this sort do not imply that China will
    attempt to dump its U.S. Treasury holdings. Rather, they
    indicate that China's leaders are aware that, while they can
    purchase more or fewer USD-denominated assets at their
    margin, their holdings are so enormous that they cannot
    reallocate the currency composition of their portfolio to any
    meaningful extent without leading to large capital losses and
    thus further public -- and internal -- criticism.

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

    PICCUTA

`