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World
Print Edition> World
UPDATED: March 16, 2007 NO.12 MAR.22, 2007
The Downside of Openness
The opening of China's financial markets may not be the key to resolving the U.S. trade deficit
By MEI XINYU
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Of course, the optimal debt-to-equity ratio in the East Asian economies is higher than that of Europe and the United States. This is natural as East Asia's economic takeoff, from the "Japanese miracle" in the 1960s to the "Chinese miracle" since 1980, mainly relies on its manufacturing prowess. East Asia is no match for Europe and the United States in terms of the capability of technological innovation, brand recognition and other intangible assets. Even in the chain of the emerging hi-tech industry, the greatest advantage of East Asia lies in the manufacturing segment.

Famous financial expert Steward C. Myers pointed out that tangible assets are easy to transfer after bankruptcy, whereas intangible assets such as technology and human resources are difficult to resell. So, a capital-intensive firm has lower bankruptcy costs than one that owns large intangible assets. That's why the former has a higher optimal debt-to-equity ratio, the expert explained.

If it opens its financial markets too fast and by too large a margin, China will not be able to effectively deal with the impacts of capital flows in the short term. In theory, granting foreign companies market access to the financial services sector does not necessarily mean the opening of the capital account. However, it may implicitly facilitate cross-border capital flows, fueling their volatility.

Private capital flows to a large extent hinge on the maturity of the market. Western institutional investors usually regard investment in emerging markets as "marginal investment." When the yield of the mainstream investment is low, marginal investment can serve as a supplement. As a result, the investment in emerging markets is more sensitive to the changes in international interest rates.

Interest rate fluctuations in Western countries may lead to dramatic changes in the amount and direction of capital flows. If interest rates rise, the investment in emerging markets may flow back. The rapid increase in the investment in emerging markets in the early 1990s is partly attributed to the low interest rates in major Western countries at the time. In 1994, the U.S. Federal Reserve initiated a series of interest rate hikes. The moves triggered an investment backflow and were allegedly responsible for the economic crisis in Mexico at the end of the year.

After 12 interest rate hikes since June 2004, the present U.S. economy is characterized by "high interest rates, a strong dollar and a huge deficit." Given these prominent features, capital flows to emerging markets are at the imminent risk of being reversed.

The author is a scholar at the Chinese Academy of International Trade and Economic Cooperation under the Ministry of Commerce

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