Systemic financial market changes in Western economies during the 1980s were routinely called “Big-Bang reforms.” That long, and still unfolding, process started in London and continued, in a much more radical fashion, in Paris, Frankfurt, Madrid, and many other European capitals to make possible the EU’s single market and the introduction of the common legal tender.

The EU is still struggling with the banking union and, perhaps more importantly, with the fact that eight of its member states remain outside the euro area. At the same time, American regulatory authorities are tightening up and updating prudential oversight, trading practices and investor protection in the wake of the 2007-2012 global financial crisis.

That is a reminder of the enormous amount of work facing China in its efforts to build a sound and resilient financial system to serve a rapidly developing global economic powerhouse.

The role of that system cannot be overemphasized. Its asset markets and banking industry are the key channels for allocation of domestic savings and foreign capital inflows to private and public investments that lay the foundation for China’s steady and noninflationary economic growth.

Capital account controls are essential

That crucially important function of financial intermediaries (between savers and investors) is often forgotten, or simply ignored, in “financialized” economies floating on trillions of funds in markets already flooded with dangerously excessive liquidity.

In such an environment, it is impossible to build and control a financial system that is open to global asset flows while keeping in place credit policies that are consistent with stable prices and a sustainable growth of output and employment.

East Asia learned that the hard way. Those who were gorging with relish on foreign capital inflows in the late 1990s are still barricaded behind strict and elaborate capital controls and appreciate, to this day, China’s helpful economic policies at the time they suffered deep recessions.

Watching all that, India was telling the East Asians “we told you so,” because Delhi never even contemplated such liberal capital market regimes.

China, of course, knows all that.

Beijing, therefore, needs no convincing that it must have water-tight controls on capital account transactions if it wants to retain autonomy in monetary policy and in the overall economic management.

But China’s problems don’t stop there.

In a fully dollarized global economy, where the U.S. currency can operate as a key vector of sanctions and other measures of strategic competition, containment and systemic rivalry, capital controls are not enough. Digital gadget antidotes to the almighty greenback won’t do it either.

The only way out for China is to (a) grow its huge potential of domestic markets, and (b) stay open to foreign direct investments and foreign trade in goods and services.

That should naturally lead to a greater use of Chinese currency in international transactions, and, in time, to one of the dominant shares in official reserve assets.

Patience, I was told, was the essential part of the Oriental wisdom – a friendly reminder to an American expecting quick deals during hasty Asian trips.

China should balance its U.S. trade

There was plenty of such advice on offer last Friday (July 9) as the Americans and the Chinese were celebrating in Beijing the 50th anniversary of Henry Kissinger’s secret flight to China to prepare President Richard Nixon’s state visit in February 1972.

As always, Kissinger was short on operational advice; he just urged the two sides to talk because the nuclear-armed adversaries could not fight. But Winston Lord, his long-time assistant and a former U.S. ambassador to Beijing, filled in by saying that U.S. and China could talk about climate change, the raging Covid-19 pandemic and nuclear nonproliferation.

Great advice, isn’t it, while the message coming over the newswires told the world that Washington was adding more than 10 Chinese companies to its black list for their alleged human rights violations in China’s predominantly Muslim province of Xinjiang.

And that’s on top of the Pentagon’s public admission that it had no emergency channels with Beijing in case U.S. and Chinese air and naval assets operating in close proximity in the South China Sea came to accidentally lethal encounters.

The sad truth is that there is nothing Washington and Beijing can talk about with respect to China’s contested maritime borders, the standoff on the Korean Peninsula, Taiwan, Hong Kong, Tibet, human rights and allegedly unfair trade policies. Those are all China’s red lines and/or issues of sovereignty and territorial integrity.

Under those circumstances, Beijing will have to go far beyond technical adjustments to its broad panoply of capital controls to protect its economy and financial markets.

One of the best and easiest things China could do there is to promptly balance its trade accounts with the U.S. That would take out of the way a huge irritant in deeply strained bilateral relations, and it would also lead to China’s more diversified trade flows.

Such a practical step would go much further in relaxing the existing tensions than multilateral talking shops on climate, the Covid-19 pandemic and nuclear nonproliferation.

The EU and East Asia may also help, because they apparently want to stay out of vacuous U.S.-China adversarial games. East Asia, in fact, has made that clear, while France, Germany and the EU leadership sounded quite conciliatory and constructive last Monday (June 5) during their online meeting with China’s President Xi Jinping.

Washington, therefore, may reconsider its lonely no-win China gambit to focus, instead, on winning strategies by significantly upgrading healthcare, infrastructure, science and education.