Today’s biggest piece of news received a mere two paragraph blurb onReuters, and was thoroughly ignored by the broader media. An announcement appeared shortly after midnight on the website of the People’s Bank of China.***Reuters provides a simple translation and summary of the announcement:
“China hopes to allow all exporters and importers to settle their cross-border trades in the yuan by this year, the central bank said on Wednesday, as part of plans to grow the currency’s international role. In a statement on its website http://www.pbc.gov.cn, the central bank said it would respond to overseas demand for the yuan to be used as a reserve currency. It added it would also allow the yuan to flow back into China more easily.” To all those who claim that China is perfectly happy with the status quo, in which it is willing to peg the Renmibni to the Dollar in perpetuity, this may come as a rather unpleasant surprise, as it indicates that suddenly China is far more vocal about its intention to convert its currency to reserve status, and in the process make the dollar even more insignificant.International Business Times provides further insight:This is all part of China’s plan for the internationalization of its currency, which may, in the decades to come, threaten the global ‘market share’ of other currencies like the US dollar.
Previously, China also announced that bilateral trades with Russia and Malaysia will begin to be conducted with the yuan and the ruble and ringgit, respectively.
Other moves on the part of China to internationalize its currency include allowing foreign companies to issue yuan-denominated bonds and relaxing rules for foreign financial institutions to access the yuan.
Aside from the efforts of the Chinese government, fundamentals also point to the increasing international popularity of the Chinese currency.
China is already the leading trade partner with Australia and Japan. It’s also the leading or a large trade partner with many of its smaller neighbors. The purpose of having foreign currencies is to conduct foreign trade and investment, so the yuan is expected to become a more attractive currency for China’s trade partners, espeically as the government continues to relax restrictions.The reason for this dramatic move may be found in what Stephen Roach [former chief economist for Morgan Stanley, and now director of Morgan Stanley Asia] wrote a few days ago in Project Syndicate:In early March, China’s National People’s Congress will approve its 12th Five-Year Plan. This Plan is likely to go down in history as one of China’s boldest strategic initiatives.
In essence, it will change the character of China’s economic model – moving from the export- and investment-led structure of the past 30 years toward a pattern of growth that is driven increasingly by Chinese consumers. This shift will have profound implications for China, the rest of Asia, and the broader global economy.
Like the Fifth Five-Year Plan, which set the stage for the “reforms and opening up” of the late 1970’s, and the Ninth Five-Year Plan, which triggered the marketization of state-owned enterprises in the mid-1990’s, the upcoming Plan will force China to rethink the core value propositions of its economy. Premier Wen Jiabao laid the groundwork four years ago, when he first articulated the paradox of the “Four ‘Uns’” – an economy whose strength on the surface masked a structure that was increasingly “unstable, unbalanced, uncoordinated, and ultimately unsustainable.”
The Great Recession of 2008-2009 suggests that China can no longer afford to treat the Four Uns as theoretical conjecture. The post-crisis era is likely to be characterized by lasting aftershocks in the developed world – undermining the external demand upon which China has long relied. That leaves China’s government with little choice other than to turn to internal demand and tackle the Four Uns head on.
The 12th Five-Year Plan will do precisely that, focusing on major pro-consumption initiatives. China will begin to wean itself from the manufacturing model that has underpinned export- and investment-led growth. While the manufacturing approach served China well for 30 years, its dependence on capital-intensive, labor-saving productivity enhancement makes it incapable of absorbing the country’s massive labor surplus.
Instead, under the new Plan, China will adopt a more labor-intensive services model. It will, one hopes, provide a detailed blueprint for the development of large-scale transactions-intensive industries such as wholesale and retail trade, domestic transport and supply-chain logistics, health care, and leisure and hospitality.Obviously, a reserve currency would be not only extremely useful, but quite critical in achieving the goal of China’s conversion to an inwardly focused, middle-class reliant society. And even that would not guarantee a smooth transition. However, should China really be on a path to a step function in its evolution, the shocks to the system will be massive. Roach puts this diplomatically as follows:But there is a catch: in shifting to a more consumption-led dynamic, China will reduce its surplus saving and have less left over to fund the ongoing saving deficits of countries like the US. The possibility of such an asymmetrical global rebalancing – with China taking the lead and the developed world dragging its feet – could be the key unintended consequence of China’s 12th Five-Year Plan.A less diplomatic version implies that the relationship between China and the US would suffer a seismic shift in which the game theoretical model of Mutual Assured Destruction, and symbiotic monetary and fiscal policies, would no longer exist, allowing China to pursue its fate completely independent of any economic shocks that the increasingly distressed United States may be going through.And confirming that the PBoC announcement is far more serious than the amount of airtime allotted to it by the mainstream [U.S.] media, is the just released article in Spiegel “China Attacked the Dollar” (google translated):The Chinese central bank surprised with a spectacular announcement:The would-be superpower wants to handle their entire future foreign trade in yuan, not in dollars. Beijing shakes America’s claim to represent the key currency – with serious consequences for the U.S..
The announcement was inconspicuous , but it has the potential, to permanently change the balance of power on the world currency market: China strengthens the international role of the yuan. All exporters and importers will, this year, be allowed to settle their business with their foreign partners in Yuan, the central bank said on Wednesday in Beijing.
This will respond to the growing importance of the yuan as a global reserve currency. “The market demand for cross-border use of the yuan rises,” said the central bank. The PBoC had previously tested this plan by allowing 67 000 enterprises in 20 provinces to run their business abroad in yuan. The trade volume amounted to the equivalent of €56 billion.
Now the amount of yuan to be extended, it should be handled much more business in Chinese currency – and less in the U.S. Chinese companies trade at present often in dollars, they are thus dependent on the decisions of the U.S. Federal Reserve to pay on it in a rising oil price and will have pay higher transaction fees than necessary. That should change now.
Currently, the People’s Republic can hardly take yuan out of the country and even that is monitored within the boundary of all legitimate capital flows. Chinese exporters have to change a large part of their euro, yen or dollars at a fixed rate revenue in yuan. Foreign companies wishing to do business in China must do so in Yuan, they can exchange their money in the People’s Republic. Tourists are allowed a maximum of 20,000 yuan and exporting. Yuan an international market can not occur – and not on supply and demand-based exchange rate.Needless to say, should the yuan be seen increasingly as a reserve currency, all of this, and virtually everything else is about to change.The only question is whether or not the Yuan will cement its status at the top of the currency pyramid by allowing the backing of the currency with individual or a basket of commodities. If that were to happen, it would be the last nail in the coffin of the already terminally ill dollar.
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While the US is hell-bent on meddling (at tremendous expense) in the affairs of at least 140 countries where its troops are stationed, China seeks to assimilate technology at little expense.
The Wall Street Journal puts it much more politely. Please consider U.S. Firms, China Are Locked in Major War Over Technology.
China’s bureaucrats have been rolling out an array of interlocking regulations and state spending aimed at making their country a global technology powerhouse by 2020.
To hear U.S. business executives describe it, Beijing’s mammoth new industrial policy is like the Borg in “Star Trek”—an enormous organic machine assimilating everything in its path, in this case the inventions of other nations. Notably, China’s road map, which is enshrined in the “National Medium- and Long-Term Plan for the Development of Science and Technology (2006-2020),” talks in those terms. China will build its dominance by “enhancing original innovation through co-innovation and re-innovation based on the assimilation of imported technologies.”
The 44-page report, “China’s Drive for ‘Indigenous Innovation’: A Web of Industrial Policies” maps the complex set of new initiatives that foreign companies face.
It also sent up a warning flare over the broader business community. Representatives of companies as diverse as IBM, Praxair, Microsoft, Alstrom, Motorola, Cisco, Corning and Caterpillar got briefings. Chinese academics also lined up. And GE distributed the report to its senior management.
China’s “Borg Strategy”
Inquiring minds are reading China’s Drive for ‘Indigenous Innovation’: A Web of Industrial Policies for details of China’s Borg-like strategy. Here are some snips from the 45 page PDF.
Indigenous innovation is a massive and complicated plan to turn the Chinese economy into a technology powerhouse by 2020 and a global leader by 2050. The landmark document that launched the campaign carries the bureaucratic title “The National Medium- and Long-Term Plan for the Development of Science and Technology (2006-2020)” (now known in the West as the MLP). Bland as the title may be, the MLP describes itself as the “grand blueprint of science and technology development” to bring about the “great renaissance of the Chinese nation.”
The MLP blueprint is full of grand visions, good intentions and gilded rhetoric about international cooperation and friendship. But it is also steeped in suspicion of outsiders.
The MLP explicitly states that a key tool for China to create its own intellectual property and proprietary product lines will be through tweaking foreign technology. Indeed, the MLP defines indigenous innovation as “enhancing original innovation through co-innovation and re-innovation based on the assimilation of imported technologies.” It also warns against blindly importing foreign technology without plans to transform it into Chinese technology. The report states: “One should be clearly aware that the importation of technologies without emphasizing the assimilation, absorption and re-innovation is bound to weaken the nation’s indigenous research and development capacity.”
China so far seems to be oblivious to the impossibility of having it both ways, hunkering behind the “techno-nationalism” moat at home while reaching into the global network of science collaboration and research. What is worrisome for the business community is that these indigenous innovation industrial policies are headed toward triggering contentious trade disputes and inflamed political rhetoric on both sides.
Many multinationals are increasingly dependent on their China profits. As one conglomerate strategist said: “We can’t afford to antagonize China.” Behind the smiling faces they display in Beijing, many foreign tech executives are rethinking their China plans as they try to figure out whether they should, or how they can, adjust to the new Chinese system. Some figure that they may be better off entering into technology partnerships with Chinese government companies to have their products qualify as indigenous innovation and reap the profits for a few years before unloading those divisions as it becomes apparent their global prospects are likely doomed by the China deal.
As political tensions rise over indigenous innovation, the Obama administration and Congress should understand this is not just another run-of-the-mill China policy dispute that can be addressed through new rounds of bilateral diplomatic discussions and bombastic legislative initiatives.
A RAMBLING PLAN OF BREATHLESS AMBITION
The plan targets 11 key sectors for employing technology development and innovation to solve China’s problems. They include energy, water and mineral resources, environment, agriculture, manufacturing, transportation, information and services, population and health, urbanization, public security and national defense. Within these sectors, there are 68 priority areas that have clearly defined missions and expectations of technology breakthroughs. It also earmarks eight fields of technology in which 27 breakthrough technologies are to be pursued. These include biotech, information technology, advanced materials, advanced manufacturing, advanced energy technology, marine technology, laser technology and aerospace technology.
MEGAPROJECTS FOR “ASSIMILATING AND ABSORBING”
According to the MLP, as the “major carriers of uplifting indigenous innovation capacity,” the megaprojects are aimed at “assimilating and absorbing” advanced technologies imported from outside China so the country can “develop a range of major equipment and key products that possess proprietary intellectual property rights.” The government procurement market is assigned to be a key driver for these projects. The plan calls for creating a buy- China policy for government procurement and expanding the creation of China’s own technology standards to get out from under the burden of paying license fees and royalties to foreign companies.
FILLING UP THE TOOLBOX
The goals of China’s indigenous innovation campaign and the megaprojects are implicit and clear – capture the market space for domestic Chinese firms with SOEs having the favored position. For example, the official goal of China’s “Next Generation Wireless Broadband” megaproject is called the “1225 strategy,” the goal of which is to capture 10 percent of global patents, 25 percent of the telecom semiconductor market, 20 percent of the global broadband hardware market and 50 percent of the domestic market.
INTELLECTUAL PROPERTY RIGHTS AND WRONGS
As in many developing countries, much of Chinese industry got started by copying the products of others. Chinese law makes it difficult to find smoking guns if proprietary technology is stolen or leaked. As a result, some companies have become masterful in using pilfered blueprints and designs and sophisticated reverse engineering techniques to copy foreign products and jumpstart their companies. The patent system also enabled Chinese parties to “hijack” patents of others – by claiming a patent on an invention that was not published anywhere in the world or sold in China, such as for a product invented by another and revealed at a foreign trade show. LOCK AND LOAD YOUR PATENTS China’s patent regime has been tailored to help accomplish two major indigenous innovation goals. One is to incentivize Chinese companies to file patents that contain little substance so that they can learn the patent process for later filing of real invention patents. The other is for Chinese companies to be able to use domestic patents to retaliate against foreign companies which file intellectual property infringement lawsuits offshore that stymie the international expansion plans of Chinese companies. The key tool for accomplishing this is China’s use of the German “Gebrauchsmuster”, or “utility model” patent.
Such patents don’t exist in the US. Filings of these patents are not reviewed, and require only vague information. They can be used to obtain patents that are merely descriptions of products owned by others with a few small changes added in. China’s patent law also follows the European “first to file” and not the American “first to invent” principle. As a result, Chinese companies are able to obtain patents for products they didn’t invent but for which they filed the patent first. The definition of “invention” in Chinese patent law is also quite relaxed: “any new technical solution relating to a product, process or improvement…”
FRENCH LESSONS AND HOME COURT ADVANTAGE
These “junk patents” are proving to be a potent weapon against foreign companies. This became clear in September 2007, just three months before the list of 16 indigenous innovation megaprojects was unveiled. IP attorneys globally sent alert memos to their clients after the Intermediate People’s Court in the coastal city of Wenzhou ordered the French electronics giant Schneider Electric to pay the Chint Group of Wenzhou RMB 334.8 million (about US $50 million) in damages for infringement of Chint’s China “utility model” patent.
DAMNED IF YOU DO, DAMNED IF YOU DON’T
The indigenous innovation drive is forcing foreign technology companies to anguish over balancing today’s profits with tomorrow’s survival. With its extraordinary infrastructure plans and a continental-sized consumer market that has just begun to really develop, China is a market no multinational can ignore. But the price of admission is getting more expensive by the day as China opens its policy toolbox to ensure that foreign technology allowed into China is accessible for “co-innovation” and “re-innovation” by Chinese companies.
ON THE FAST TRACKS
It is no surprise that the world’s train makers are transfixed by China, especially those who make high speed rail equipment. Dragonomics Research estimates that half of that US $730 billion will go toward building 16,000 kilometers of high speed rail lines—four north-south, four east-west and 19 inter-city lines. With 30,000 employees, 90 operating companies and 61 regional offices in China, Siemens tracks these trends very carefully.
BLOWING IN THE WIND
Technology transfer has always been the key priority in China’s wind energy sector. China’s domestic wind energy industry took off with the help of a set of major policy developments. In 2005, the NDRC required that all wind turbines in China must have at least 70 percent domestic content. Some leading foreign wind turbine manufacturers such as Vestas, Gamesa and Suzlon decided to operate independently despite these regulatory barriers. GE and a few others chose to follow the policy path. Technology transfers together with government financial subsidies, preferential tax policies and preferential treatment in project tendering and bidding have fueled rapid growth of domestic companies. In 2004, foreign wind turbines had a 75 percent market share in China. By 2009, the three largest domestic players, Sinovel, Goldwind and Dongfang alone had 60 percent of the market — and the foreign share was down to 14 percent.
COME FLY WITH ME
In no other project or sector can the Chinese government’s indigenous innovation campaign be seen more clearly than aerospace which is fueled by the country’s aspiration to design and manufacture a large commercial aircraft that can compete with Boeing and Airbus. And this endeavor is well underway. China has set the year 2014 as the target for the first test flight of its home-grown 150-seat airliner, known as the C919. Commercial flights are planned to begin in 2016.
While China accumulates patents by hook or by crook, the US is bogged down in Afghanistan and Iraq. Moreover, we have troops stationed in 140 countries around the globe in a futile attempt to be the world’s policeman.
Does China waste money on troops stationed elsewhere?
Instead of building bridges like China does, we bomb bridges to smithereens in places like Iraq and Afghanistan, then rebuild them at US taxpayer expense.
Bear in mind I certainly am not in favor of China’s state-owned-enterprises (SOEs) or its massive unsustainable spending on infrastructure and housing. However, one can make a case that at least China gets something useful out of its investments while the US sends $trillions down a black hole of 100% useless military endeavors, making millions more enemies in the process.