To be published as HC 1474-ii

House of commons



Treasury Committee

Global imbalances

Wednesday 25 January 2012

Dr David Vines, Dr Linda Yueh and Dr Kerry Brown

Evidence heard in Public Questions 31-89



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Oral Evidence

Taken before the Treasury Committee

on Wednesday 25 January 2012

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Stewart Hosie

Andrea Leadsom

Mr Andy Love

Mr Pat McFadden

John Mann

Jesse Norman

Mr David Ruffley

John Thurso


Examination of Witnesses

Witnesses: Dr David Vines, Professor of Economics, Balliol College, Oxford University, Dr Linda Yueh, Director of the China Growth Centre and Fellow in Economics at St Edmund Hall, University of Oxford, and Dr Kerry Brown, Head, Asia Programme, Chatham House, gave evidence.

Q31 Chair: Thank you very much for coming to see us this afternoon. This is a big issue, hotly debated; it will not go away and some say it is getting worse, so I think it would be very helpful to get your views this afternoon. I would like to begin with a general question that draws on the fact that we have had some pretty contradictory views on this from some of our most eminent former practitioners and current practitioners of economic policy and then ask you to comment on it.

Mervyn King, Governor of the Bank of England, said that the causes of the unsustainable build-up of debt in Europe and elsewhere lie "in the continuing imbalance between those economies running large current account surpluses and those running large current account deficits"-in other words, what most people perceive to be the global imbalances. Nigel Lawson, former Chancellor, on the other hand, says that that is a misidentification of the problem and that in fact it is just an inevitable consequence-I am paraphrasing now, rather than quoting-of what he describes as the second coming of globalisation. I am sure you will have seen these articles and speeches that they have delivered and I wonder if you would like to start.

Dr Vines: Chairman, thank you very much. I think that those two views are closer together than they might appear. The core identified by both Nigel Lawson and Mervyn King is that when countries in different parts of the world have what you might call imbalances between savings and investment, then this inevitably, as a matter of adding up, washes out in China’s case exporting much more than it imports. There was a period in the crisis where world demand for Chinese exports collapsed and it looked as if this was normalising, but actually it was just a blip. This is an underlying structural feature of the nature of Chinese development and that-

Q32 Chair: Nigel Lawson is saying that we should not try to bring pressure to bear and develop policies to address it, that we should accept it as inevitable. He is furthermore saying that the policies that Mervyn King has been proposing-he says of Mervyn, "I have known him well for many years. He has proved to be an excellent governor through a testing time. On this issue, I believe him to be mistaken."

Dr Vines: There are two periods. No problem until the crisis broke. There is a wonderful piece that I would recommend to everybody-extraordinarily clear-by Olivier Blanchard and Milesi-Ferretti on the IMF website about when imbalances matter. In the great moderation the Chinese had a growth model that worked like this and the US had a policy constructed around ensuring, with low interest rates, that even though the Chinese exported a lot and took demand from our goods, we would have low interest rates and the world would grow. This worked fine until 2008 when deleveraging happened everywhere and suddenly that policy of making that work required world real interest rates of minus 4. When you end up in that world, then this growth model is part of the world’s problem of not having enough demand because then East Asia, following China, have a growth model that-to call a spade a spade-steals demand from other people because they export a lot. In the great moderation, wonderful, lots of cheap stuff from them. When the crisis comes we now have managing our way out to find growth, and there are many problems in the world that stand in the way of that, but one of them is that East Asia could be rebalancing faster.

Q33 Mr McFadden: Why are these imbalances a bad thing?

Dr Vines: That was my distinction between the two periods. In the earlier period getting cheap exports from China-everyone said after the Asia crisis, "The world is falling to bits; the IMF are wrecking Asia." It took about four years to realise that this was the beginning of an extraordinary decade in which we got stuff cheaply from them, but the imbalances themselves are not what is wrong.

The imbalance is the inability to manage the world properly. In the great moderation the world was well managed with imbalances. If there were rebalancing, we would then find that they were buying more imports and selling less exports, and that is what we need. It is a question of managing the world rather than saying, "If you spend more money than you get then somehow you are wrong and the world will unravel." It is not the imbalances. It is that they reflect a mismanagement of the world. The IMF and G20 MAP are trying to do this at a global level, and as and when that works the imbalances will reduce.

Dr Yueh: If I could just add, what Nigel Lawson is referring to is some of the structural imbalances of having, like David mentioned, export-orientated economies and then a degree of dis-saving that became very apparent over the last decade. Of course, what Mervyn King is talking about is the fact that at the same time this dis-saving in the West was associated with cheaper borrowing costs. Let me just talk through what this means.

There have been global imbalances for many years before the last decade, certainly before the last 20 years. The United States has run a current account deficit-that is, a trade deficit plus a deficit of inflows of investment funds-implying that they do not quite save enough for the investment in their own economy, but it is the magnitude of the imbalance that has changed over the last 15 years. So what has changed over the last 15 or 20 years? It is the globalisation, the global reintegration of very big emerging economies. China 1992’s open-door policy took off. India turned outward after its 1991 balance of payments crisis, although India is not a big contributor because it actually runs a slight trade deficit. But the idea that you now have a country as big as China and the rest of East Asia still practising very export-oriented growth was one of the reasons why this imbalance, which has existed for several decades, became increased in magnitude in the 2000s. At one point the US current account deficit was as high as 6% of US GDP and the yield of that is the surplus run by not just China but, if you look at the breakdown-the IMF has done a breakdown of surpluses-China and then if you add Japan and Germany together, that is almost as big as the Chinese surplus, then oil exporters as well also running surpluses because they are doing very well because they are selling to these newly industrialising countries of China, India and what have you. There is a confluence of factors at play here. The fact that the imbalances rose meant that the surplus countries-not all of them, but a number of them like China-were intervening in their currencies to keep their currencies competitive, consistent with an export-led growth strategy. That mean they were accumulating reserves. Those reserves included purchases of Treasuries-long-term debt issued by the United States.

Again, and I think this is in Mervyn King’s own paper, he cites some research that suggests that that has pushed down the yield-that is, the bond cost on 10-year Treasuries-by some 85 basis points just from central banks demanding US Treasuries, but that is not a causation. This is simply a set of factors that happened over this decade. Alongside of this there was financial deregulation that was set up in the United States after 1999-a whole series of factors against which this is part of the backdrop.

So, is it good or bad? It is in a sense the consequences that need to be looked at, and indeed the US current account deficit has now come down. It is now about 3% of US GDP and that implies the surpluses of these countries are also coming down because, as David said, there is a decline in global trade, had been in 2008, and we are already seeing a decline again in global trade.

Q34 Mr McFadden: Can I ask you about self-interest? In these discussions about imbalances you talked about running the world. Countries do not come at these issues from the point of view of running the world. They come at these issues from the point of view of what is in their own interest. China is asked to do at least two things that come to mind consistently by other countries. It is asked to grow domestic demand and place less emphasis on exports, though it has done extremely well as an export-oriented economy, and it is asked to allow its currency to increase in value relative to other currencies. Why should it say yes to either of these things if it considers that the current model is serving itself well? We have the same argument within Europe between Germany and some of the other eurozone states. I think one German person said, "Why should we become more like the bad countries if you want it to look like that?" Why should China do these things?

Dr Vines: I remember this being discussed at a meeting in Paris before the French G20. I do not think you can ask countries to act unless they see reward generously, to put it bluntly. The two of you will need to come back on this to see if you agree. I think that what is now being done in China is not in their interest because they face a world north-the Atlantic economies-with interest rates that are so low that it is exceptionally hard to run the Chinese economy coherently. I am not the one to know about details, but we have been through a very difficult time for them with a bubble in the property economy because interest rates like zero are not what you need in a very rapidly developing economy. The way round this is for an appreciation of the exchange rate.

Q35 Mr McFadden: Do they agree with you?

Dr Vines: Some do and some do not. We are looking at very serious policy conflict in China about that.

Chair: Could we bring in Dr Brown?

Dr Brown: I can’t talk about the economics, but I think politically there is no reason why they would at the moment. Maybe in a year or two’s time, but why would they give in to this pressure now? They see a contemptible environment around them that was not of their making. In the current 12th five-year programme, which started at the National People’s Congress last month, or slightly before that, they spelled out their macroeconomic objectives and those are primarily to do with building social welfare to deal with the huge inequalities in China. The failure of the Hu Jintao and Wen Jiabao period is these enormous inequalities, and, therefore, from the leadership compound in Zhongnanhai they see a world around them that has critical issues of lack of spending in education, which I think is about 1% or 2% of GDP, and health care, enormous inequalities in society, 150 million people living below the poverty line. Xi Jinping, who is likely to be the next Party Secretary from October this year, said famously in Latin America last year, "We have a lot of whingeing foreigners saying that they need us to help them out". Politically I do not think that they, but the key thing is probably-

Q36 Mr McFadden: So, "Stop selling us stuff" is not a very appealing message.

Dr Brown: In fact they do import a lot. They do import a huge amount, just not from us. The key thing is probably a quite quick decision on the internationalisation of the renminbi, beginning with small steps. London has obviously been involved with that, but I think probably quicker than we think they will make a big policy change there. Maybe we need to think about how we work with that rather than expecting an anxious Chinese middle class, who are smaller in proportion than we think, to start buying luxury goods from the West.

Dr Yueh: If I could just add, the reason why the Chinese would think about relying more on domestic demand, rebalancing the economy now, is entirely practical. They do not think that export growth will be at the same pace that it has been for the past 20 years because they see the amount of deleveraging in the West. In my discussions in China, the 12th five-year that Kerry mentioned is a serious rebalancing towards domestic demand. However, let me make one caveat. This does not necessarily mean they want just to export. It means a relative increase in domestic demand. If you look at a country like the United States, it is one of the three biggest traders in the world, but predominantly the economy is driven by domestic consumption and investment; the same with Japan, the world’s fourth biggest trader. Germany is the exception, but that has to do with the EU single market. It is certainly a different case.

What the Chinese are thinking in terms of the next five to 10 years is that exports are not likely to be the engine that it was. Its own middle class now has a higher level per capita income, enabling them to grow much more by internal demand. That is why their plans now are to increase urbanisation; improving comfort, especially for the rural population; develop a services sector. Of course, services are partly non-tradable-things like getting your hair cut. All of these things is a shift in focus and, as a consequence of that, of course, there will be implications in terms of the structure of the world economy as the Chinese become much more rebalanced towards their own drivers.

I just want to focus a moment on this savings and consumption point. The argument within China, echoing what Kerry just said, is it is not necessarily the case that the households have to save less. There are lots of reasons for why it is households save about 22% of GDP, but it is retirement, an inadequate social welfare system. If you look at the increase in savings, over the last 10 years it comes from firms. Firms save 22% of GDP and the concerns there are that firms save for a variety of reasons, including the fact that interest rates are not market-based, like David pointed to. There is distortion in the way that loans are made, so they save if they want to make sure they can access credit for investment. All these reforms are being talked about in China. They realise this is not the best way to grow. They need to have more efficient allocation of capital and so that means that you could see some changes on the firm savings front and then, therefore, rebalancing of the internal Chinese economy, as I say.

Dr Vines: Partly coming that way.

Dr Yueh: Exactly. Just very finally on the currency, I know it does not seem like it, but the Chinese currency had the single biggest year of appreciation last year against the US dollar of 4.4%. It briefly strengthened beyond 6.3% against the US dollar and, again, as the economy begins to rebalance, having a slightly stronger currency is good for inflation, reduces the cost of imports that need to go into industrialisation, intermediate goods and that type of thing. It is all happening rather gradually, but not in response to pressure being exerted by the West.

Q37 Andrea Leadsom: That was really interesting, Dr Yueh. To what extent, then, would each of you favour a natural move towards a rebalancing of the imbalances? From what you are saying, Dr Yueh, it sounds as though there is that kind of natural move towards, as the economy in China develops, that domestic demand will naturally start to take over. Is my understanding of that correct or is there some push required by politicians?

Dr Yueh: I think this is a process that will continue and it will mean that in the future China is unlikely to run the kind of size of current account surplus that it has in the past. In terms of what this means on a policy front, I do not disagree with the notion that the IMF or a global body should be monitoring the consequences of the structural readjustment in the world economy because clearly it is the impact of reserve accumulation and liquidity that is the worry in the West for the most part.

I suppose on that front I would also point out another trend happening in China that could help. Chinese foreign exchange reserves-we know this is a very big number, $3.2 trillion-have come down slightly in the last quarter. The reason is in part because they have let the currency appreciate, so they have had to intervene less, but it is also because China is going global, it is going out. It is pushing more outward foreign investment. In other words, instead of foreign investment into China, they are investing more overseas.

Last year, there was a record $116 billion of outward investment from China. As capital flows out of China, that means that they can buy real assets, like a share in Thames Water, instead of buying Government debt, adding to liquidity. In that sense there is also another trend and the main reason they are doing this is very straightforward. They want to diversify their investments. They are a bit concerned about returns on Government debt. Also they want multinational corporations, because this is how they can ultimately foster their own development, overcome what is called the middle-income-country trap where lots of countries grow well to a certain level-about US$14,000-and then find it hard to grow well after that. The countries that have done it have had multinational corporations, competitive on a global scale. They are using their reserves to fund these investments. So that is another trend that would help with the rebalancing from the Chinese perspective.

Q38 Andrea Leadsom: Thank you. Dr Vines, do you think it is just going to happen or does it need pushing?

Dr Vines: Yes, it is going to happen. Your question is exactly the right one-is it happening fast enough? That is a global question. If there were demand coming from elsewhere then it might well be fast enough. Step back in history. This is an extraordinary period. This is like the first 10 years of the 20th century. That was the end of the British Empire and the period from 1914 to 1945 was an extraordinarily bad way of the end of the British hegemony. Notwithstanding the extraordinarily wonderful State of the Union speech last night, we are now at the end of the period that we have had since 1945 when there was a global hegemony. Managing the world so that it does not repeat, as we are trying to do desperately at the moment, the mistakes of 1925 and 1931 is a question of global responsibility. You can see I know much more about this stuff and much less about details about China, but about this stuff it is going to, importantly, involve China accepting a position of international responsibility to help ensure that the world grows fast.

We would be in danger of talking about Europe, and I do not want to do that. Against that background of the world not growing fast enough for it to be confident in this current recovery, we are looking for ways of global co-operation to make the recovery sustained. It is that, rather than whose imbalance is where, that is the core question at the moment. I think the Chinese are beginning to see that they have responsibilities of that kind, which are not "putting myself at risk in order to be globally responsible", but seeing that together they can help ensure that the world does grow in the next 10 years, which will help them.

Q39 Andrea Leadsom: Just a very quick answer. Dr Gerard Lyons from Standard Chartered Bank cautioned us against seeing all imbalances as a negative thing. He said imbalances can sometimes be good things if they are reflecting much stronger investment, much stronger potential for future growth.

Dr Vines: That is Lawson, yes.

Q40 Andrea Leadsom: Yes. You would agree with that?

Dr Vines: Yes, I would. You can see, within a system that works, a lot of that. It is a system that works, the problem that is pressing us at the moment.

Q41 Andrea Leadsom: Can you tell us which other key countries, other than China and the US, are affected by major imbalances? Which would you see as the big culprits and have they improved or worsened over the time, or is this just a story about West versus East with the exception of Germany?

Dr Vines: No, the other is Germany. As Linda said, there are very significant imbalances on the part of the oil exporters, but I think of them as consequence. The price of oil is extraordinarily high and there are global energy issues. They reflect outcomes. Everyone is clear that there are pressures now pushing for a lower euro and there are complicated differences of opinion in Germany, but there is a very strong push that that is what they want in Germany-a stronger euro, good for German exports.

If that is how Germany runs-constraint in the periphery and caution in the core-and you add China, things happening but at their own speed, you ask, "Does it all add up or in the end are we all trying to export to Mars because there is no one at the other end quite big enough?" We say, "The US, deleveraging, have to go carefully." If you add up these three areas, it is not quite clear that there are enough people buying and that is the insecurity about the global recovery.

Q42 Jesse Norman: If you look at the German situation, I have spoken to senior German people who will say that they are quite happy and would prefer a situation in which you have 10 years of booming growth underpinned by a low exchange rate, followed by a catastrophe, than to have an unfettered or high exchange rate, comparative to the deutschmark. How sustainable-

Dr Vines: You can see why. It is not unrelated to the Chinese growth model.

Q43 Jesse Norman: I understand that. Let me just get to the question and then ideally any of you can briefly answer. The German policy looks very simple, which is keep the pot boiling but not boiling over, use fiscal catastrophe and monetary catastrophe in the periphery to restrain interest rates, and, since they are essentially irrelevant to German demand, that does not affect exports particularly. Since the euro crisis struck there has been an enormous shift of power from France to Germany. Why on earth should Germany have the tiniest interest? Notwithstanding Martin Wolf’s suggestion that creditors and debtors are all in it together, why should they have the tiniest interest to play any other game apart from the possibility that the whole thing could go wildly pear-shaped and create a catastrophe? Why should they?

Dr Vines: I am watching people say that Mario Monti does not have more than a few months until Berlusconi tries to come back. I went to a terribly depressing meeting of Greek scholars a week ago in Oxford in which they were wonderfully articulate about how confused they were. Portugal is on the edge of-presiding over a southern Europe that is increasingly anti-German in spirit and vulnerable to extreme politics is not a recipe for running a good Europe.

Q44 Jesse Norman: Since we are running out of time, you essentially accept my analysis?

Dr Vines: Yes, and it is worrying.

Q45 Jesse Norman: Good. Therefore, you would suggest that the effect of the eurozone combined with these imbalances is essentially to create hostility and conflict rather than a context in which these policy solutions can be-

Dr Vines: That is my sense of Europe, yes.

Q46 Jesse Norman: Good. I am very keen to come on to you about Europe, but we are running out of time.

Dr Yueh: If I can quickly add something.

Jesse Norman: If you could quickly add something, I would be very grateful.

Dr Yueh: The German incentive should come from increasing its own real income. So one of the reasons why they sell so many exports is wage restraint. Productivity-adjusted wages only rose by 5% in Germany between 2000 and the decade after and it fell between 2000 and 2008. So, ultimately, they are the classic Oxford exam question, "Should a country grow by exporting as much as possible?" I think at some stage it is about incomes and, therefore-

Q47 Jesse Norman: If we have to rely on the German middle class’s appetite for higher real wages we will be waiting for a very long time. Can I ask you a question very quickly, Dr Yueh, on a completely different subject since we have little time, which is why should China create a welfare state? China looks at Europe and it thinks, "Decadent economies that have sapped the will to work." Dr Brown, why should they go down this route? Why should they accept these nostrums from economies that they regard themselves as intellectually and economically superseding?

Dr Brown: They spend US$93 billion a year on social management because of the amount of contention in society-because of extreme inequality-and that is more than their defence budget, which is US$92 billion. That is a statistic from the National People’s Congress.

Q48 Jesse Norman: More than the defence budget we know about.

Dr Brown: It is still a huge amount of money. In terms of efficiency, they would want more social welfare. There are extremes between the generations maybe before 40 who have a sense of great social entitlement and think the state in China should give them everything and those who are younger and probably do not think the state should be nosing around in their life. So there are big issues. The objective of the Chinese Government over the last 10 years has been to create a middle-income country by 2020. That is a big kind of strategy and that means per capita GDP, I suppose, at today’s level of about US$8,000 or US$9,000.

There are three big things. The first is since 2008 the political debate in China has been about the comeback of state-owned enterprises. These have been the victors. Before they thought maybe state-owned enterprises were not so important, but now they have been vindicated because they have held steady and 50% of central Government tax revenues come from state-owned enterprises. I think 20% come from foreign enterprises. There is their importance. In China I think the first golden rule is you follow the money, so state-owned enterprises are big funders. The third thing is fiscal rebalancing. The point is that the central Government raises tax but the provinces spend it. This is a fundamental political issue. You have the central Government-

Jesse Norman: We have that problem in this country as well.

Dr Brown: For instance, if you look at one of the big budget lines it is pensions, and that is a huge issue. In Sichuan province, which is 100 million people, 90% of their budget goes on pensions. That is a big political decision. Finally, when we talk about Chinese money coming abroad, it is our political failure because, yes, we have done a little bit, but in Europe it is tiny amounts. Basically, it is mostly state money, it is mostly from Beijing and it is mostly directed according to political fiat. We have not made them a compelling case of why they should invest here and certainly on the eurobonds, as Klaus Regling, when he went to Beijing last October, hilariously said, he had not gone to the Chinese Government to ask them for money; he had gone to ask them what they would say if he had asked them for money. How ridiculous is that kind of approach to them, when they would think it was our problem and we should sort it out?

Q49 Stewart Hosie: Dr Vines, it is self-evident that if we are going to rebalance it is not just the surplus countries that need to take action, but the deficit countries too. The Chancellor of the Exchequer here has said he wanted to see an increase in manufacturing for export and in lieu of imports. How important a component is manufacturing in this rebalancing that we might want to see in this country?

Dr Vines: Very important, and it will take 10 years. I have pulled that number out of the air, but rebuilding a capacity to do things is not something that you turn around and have in 18 months’ time. It is a very skilful economy with now relatively little nuts and bolts making stuff and the process of bringing back again the making stuff allied with the skill is our real national task in the next five to 10 years. The currency depreciation that we have had is absolutely critical to the rebalancing. If you listen to Farming Today-I wake up early enough to hear that-farmers are happy and, guess what, because the currency is 20% depreciated. That will be true of many things on the edge of being possible in this country.

Q50 Stewart Hosie: Let me ask you-you are serious about this-should the Government use the various fiscal tools it has-enterprise zones, targeted tax allowances, increased annual investment allowances-targeted at manufacturing or should we simply hope that the near-zero interest rate will be enough to see that investment? Should it be directed or should we just leave it alone, with your economics hat on?

Dr Vines: I do not have anything useful to say about that question. In principle, I am against the idea of picking winners. There may be important things wrong with the tax system and things we could do, but I am afraid you should ask someone who is a specialist. I suspect there might be and I would go looking, but I do not have a list of things that I know about that I would recommend.

Dr Yueh: Can I just add, there is a piece of recent research from the Centre for Economic Performance that I am part of? It is not my paper. They found that, as David said, it is not picking winners or losers, but having an active industrial management of your economy, the cost of which is not that high. It is something like $6,300 per person for a re-orientation towards just trying to develop industrial capacity, something China does very well in the Special Economic Zones. It is that type of-I suppose you can think of it as-policy direction, rather than being very specific, that can help encourage the kinds of sectors that an economy should be specialising in to ensure it does not get relegated in the globalisation race to something that is low end or services or anything-

Q51 Stewart Hosie: It is policy and it is direction rather than big money in a particular direction?

Dr Yueh: Yes.

Dr Vines: I think that is right.

Dr Yueh: Yes. I would also add one more thing that is essential. I know David picked that number out of the air, but part of rebalancing also involves having the skill to be able to realise the policy direction you need to move towards. I think that is the one lesson that lots of economies have begun to pick up in an era of increased competition and globalisation, which is you can’t sit on your hands and let globalisation take its course because it is very dynamic. You should be able to shape and mould your country’s comparative advantage or competitiveness, and you should think hard about it. Yes, the exchange rate does help and that trade has improved since sterling lost about 25% against its most-traded partners since the start of this crisis.

Q52 Stewart Hosie: Indeed it has, although last year it was still 100 billion deficit in the trade in goods, but we will park that for the moment.

Dr Vines, just one final question then. These are very useful and very helpful answers, but you said earlier effectively there is not enough demand.

Dr Vines: In the world, yes.

Stewart Hosie: In the world. So we can do all we like with the supply side. How on earth do we stimulate the demand side if you identify that as the fundamental problem?

Dr Vines: That is tough, and look at what happened in the 1920s and the 1930s. We are not in that, but we are at risk of it. Two bits of an answer: for an individual country, what this country has been trying to do to rebalance with a more depreciated exchange rate and grow your way out is what Korea and Thailand did after the Asian financial crisis. Interestingly, it is what my own country, Australia, did during the Asian financial crisis. All the markets in Asia collapsed, the Australian dollar went down 30% and Australia went on growing at 4% by sending its exports to America.

A crucial part of what we are doing as a single country is this currency movement. You can’t do that for the world and the world then asks, looking at the aggregate, how will Germany respond to requests globally to move more? How will China, bringing in train the rest of Asia with it, respond to do more? Are we, in the end, driven to keeping the recovery going by a ridiculous repeat of the "Greenspan Put" that we have to plead zero-bound quantitative easing-Obama gets more?

Because of these-guess what, I am going to use the word-imbalances in the world economy, we end up doing stuff that will come to an end down there. This is a global management problem. I think talking to the Chinese about this and about the IMF’s efforts in the G20 Mutual Assessment Process-G20 MAP-in trying to see how the world recovery can be kept going is crucial. To go back to where I started, individual countries have a plan, but our plan depends on the world and we have to make the world add up. That is a global issue.

Q53 John Mann: I just have one question. Dr Brown, I would like you to answer it first, although I would be happy to hear other comments as well. My question is this: who runs China and, in particular, its economic policy? Where does the key intellectual input come in informing those people and, in your judgment, will those power bases change in the next five years?

Dr Brown: In terms of the structure, there is a leading group on the economy that is within the Communist Party, which I think is seven members. That is chaired by Wen Jiabao at the moment, so it is chaired by the Premier, who has executive control over macroeconomics. They have the responsibility for mandating the Government at the National People’s Congress with macroeconomic policy through the five-year programmes. We used to call them plans, but they are not prescriptive now. They are really budgetary statements. This programme runs until 2015.

The residue of the state planning system is still within what we call the National Development and Reform Commission. That has quite a lot of powers over telling state-owned enterprises what to do. There are about 170 state-owned enterprises now. There used to be, obviously, many more at the central level. Those are the real commanding heights. It is a residue of the old planned economy, although I think for the importance of raising taxes they are obviously very important.

How does the Communist Party in China maintain control over these? Through appointments. The heads of the state-owned enterprises, the key ones, are appointed by the Communist Party through the Organisation Department and, therefore, you have a nexus of, yes, the leading group, the NDRC; the Ministry of Finance is not so powerful. You have some kind of controls over the State Council, for instance, which is like a kind of Cabinet, but the key decisions at the top are made in the leading group. We do not even have public recognition that it is exists, though, of course, it does exist. It does not issue documents or anything, but it is the thing that makes the final political decisions.

Dr Yueh: On economic policy, I would add to what Kerry has just said. You would look to the NDRC. They tend to be the kind of intellectual thinking through of the policy body. They are the ones who draft the five-year plans, the 30-year plans. They are the ones who bring in international experts, domestic experts. They debate what policies could work. Then within the State Council is something called the DRC. That is the Development Research Council, and they also have a lot of say in terms of filtering through the kind of economic policy direction the State Council might want to take. Those are the top economic thinking bodies.

I would probably just also add that, speaking to Chinese policymakers now, quite a lot of the discussion is about the tendencies and preferences and policy direction under the next generation of leaders. It is much more about Li Ka Shing or Xi Jinping, who are mooted to be the next generation of leaders, their take on things, increasingly so, even more than-

Q54 John Mann: Can I throw in a supplementary? I have done a lot of work on the former Soviet Union-for example, Kazakhstan, Uzbekistan and, not quite, but Mongolia-and there key Chinese input would appear to be from what I would describe as oligarchs based in China, not least in Hong Kong, who are involving themselves in the economics with the money behind them, but also the politics of those neighbouring countries. Is this a factor that is going to emerge in the near future in China?

Dr Brown: A third of the entrepreneurs in China are members of the party. Since 2002, formally they have been allowed to be members of the party.

Q55 John Mann: They are in Mongolia and in Kazakhstan as well, always members.

Dr Brown: Yes. You mean ethnic Chinese in these places?

Q56 John Mann: The oligarchs there, as are across the former Soviet Union.

Dr Brown: Are you asking do they have input into policy in China or-

Q57 John Mann: No, I am talking about the Chinese oligarchs based in China, particularly Hong Kong, and the input they are having with other oligarchs in the former Soviet Union and whether those people are having any impact yet in China.

Dr Brown: No, I don’t think so. The only thing I would say is the key Government responsibilities by elite leader after elite leader from the Great Transformation in 1978 is to take raw GDP growth and economic productivity as the key thing. You say, what is the impact of leadership transition? I think we are entering an era that, as was predicted at one of the plans in 2004, is about socio-political outcomes rather than economic outcomes where the Government will be judged. That is very, very tough, extremely difficult to build consensus around those issues. In that sense, the future leadership are going to have much tougher challenges where it is not just about producing good figures. It is going to be about producing social infrastructure and things like this to deal with some of the contention in society. That is much tougher.

Q58 John Thurso: May I ask you about the UK’s imbalances? We have had some conflicting evidence from both sides of the coin. We had evidence from Jim O’Neill of Goldman Sachs that more or less said the current account deficit in the UK is not something to worry about too much because, while there is a deficit on traded goods, there is a surplus on invisibles and if we net them off we do not do too badly, and if things get better again, it will be all right. That is a travesty of his evidence, but broadly that is it. By contrast we have had other evidence that says-and, Dr Yueh, you used the words "structural imbalances"-the structural nature of the UK’s imbalances is such that this has to be dealt with.

Can I ask the two economists, first of all, whether you think the UK’s current account deficit is a serious and ongoing problem that needs attention or a passing symptom that will go when we recover from this bout of financial flu?

Dr Vines: I think it is an outcome of having been a very uncompetitive economy since the sharp move upwards in the real exchange rate at the beginning of the Labour Government. For 10 years domestic expenditure has required tighter money and it has been a combination of the fiscal position, which turns out not to have been as careful as Gordon Brown thought it was, or as the commentators thought it was, and the private sector, armed with wealth from rising property prices. So it is private consumption as well as the Government position, meaning that this economy was only in balance with an appreciated exchange rate that crowded out exports.

I think we are in for a 10-year period of rebalancing, fundamentally by being more cost-competitive. We are watching the cut in real wages that is happening as part of that process and this will help reposition us and so I think that we will emerge with a better-structured economy and with a current account deficit position that has improved as a result of this rebalancing.

Q59 John Thurso: Just so I understand the answer you are giving me, it is that, yes, this is a very important problem and, yes, it has to be cured, and a return from deficit to surplus will be an important signal in the future.

Dr Vines: Part of that.

John Thurso: That is correct, is it?

Dr Vines: Yes, that is correct.

Q60 John Thurso: Dr Yueh, is that where you would be as well?

Dr Yueh: Yes. I think it is important in order to generate growth for the UK in the next few years. The current account deficit for the UK had averaged some 4% of GDP and Jim O’Neill is right in that there is a deficit on the trade side and a surplus on the services side for the most part. However, the overall deficit means that there was also a deficit of savings in this country relative to what is needed for investment.

Dr Vines: Which is my point.

Dr Yueh: Exactly. If you think about the amount of deleveraging that still has to happen in this country of repayment of debt, there is very little domestic demand that can be had from consumption. So it needs to be driven by investment and by exports. Therefore, for the sake of growth in this country, being able to improve the trade position, which did happen in the 1990s with a bit of a lag from the value of the currency, would reflect an increase of-

Dr Vines: 1991 to 1997, exactly.

Dr Yueh: That would itself, hopefully, reflect not just an increase in competitiveness through the exchange rate, but, through an effort to rebalance the economy-generate real productivity and competitiveness in this economy-rebalancing more towards higher manufacturing. All of that will be seen in the external deficit.

Q61 John Thurso: Can I just check that proposition, playing devil’s advocate? If financial services is the surplus part of our economy and manufacturing is the deficit part of our economy, most people heading a marketing department in a business would be, "Sell to your strengths rather than trying to eliminate your weaknesses." So why not do more financial services?

Dr Yueh: I don’t disagree with trying to build on the surplus that is there. I would broaden it out in terms of British expertise. I would not just say financial services. I would say business services, professional services, education services and other things in the services lump, which could include things like the creative industry. If you look at where demand will be in the coming years, it will be in China, it will be in India, it will be in the emerging economies of Asia, and the UK runs a trade surplus in services with China even though it runs a trade deficit in goods. As China’s services sector develops and increasingly opens, it is in the UK’s interests to try to get into that market and to support the development of that sector because the Chinese want the foreign input to help them develop that sector, which at 40% of GDP they think is low. It is low by comparative international standards and it is an important part of the rebalancing of the Chinese economy. Thinking again about growth paths, I would say that is something Britain should think very, very hard about, how to partner the Chinese in-

Q62 John Thurso: What you are saying is the ideal is we want to rebalance our economy towards real products and services without losing what we have in the services sector, but by the increase coming from the other side?

Dr Vines: Yes. Some of the financial products turned out to be imaginary and we are going to need to rebalance because of that. Again, I come back to the exchange rate. The price effect will encourage at the margin all sorts of moves in the right direction. To take your question head on, as this rebalancing happens, of the kind that Linda described, we will emerge with a current account position that is improved. I was thinking of my time at Glasgow University when we had three weeks of assets before bankruptcy. It is in those circumstances that your current account matters per se, but when you are trustworthy and your creditors trust you-you can see what I am doing. It is how it hangs out in the wash rather than the current accounting itself and getting it to hang out properly in the wash will involve improving the current account position.

Q63 Michael Fallon: Could one of you advise us on the measures they are taking in China to curb the exuberance of the property market? Have they done enough to do that or have they done too much? Who is the expert on that?

Dr Vines: You know more about that-me after you, Linda.

Dr Yueh: They are taking measures to curb the property market. In fact, the Chinese are currently talking about fiscal stimulus-more Government spending to try to boost the economy in anticipation of export weakness. They are talking about tax cuts, subsidising energy-efficient consumer goods and all those things, but at the same time the one area they are not encouraging is growth via the property sector. They said that they will continue to keep the curbs on and, in the latest figures of 70 major cities surveyed by the Chinese authorities, prices fell in 52 of them and, most notably, in the big cities of Shanghai and Beijing.

There are two schools of thought about whether it is a bubble. One is, of course, you look at ghost cities-very dramatic, and it looks like there are a lot of vacancies. If those loans go bad, can the banking system withstand it? My take has always been the banking system has a legacy of problems, of which this is one more. The other side of the argument for those who think the Chinese Government has done enough is they look at average disposable incomes and their increase in big cities relative to the increase of house prices. The conclusion there is that a lot of the housing that is bought is not bought based on debt or leverage, but rather because there are so few investment opportunities in China. Savings garners a negative real return because the deposit rate is only about 3%. Inflation has just come down, but it was well over 6% for much of the past year and certainly very high in the past few years. So I think there are two main conflicting schools of thought on that.

Q64 Michael Fallon: I understand that, but what I am interested in is, is the Government sticking to its guns on this?

Dr Yueh: They are, yes.

Q65 Michael Fallon: They are. Now, I want to ask you about debt. The official public debt, I am told, of central Government is around 19% of GDP. That does not include local government debt. Is that right?

Dr Yueh: When they report these statistics it is only central Government, but I would have to see where you are getting the 90% of GDP figure from.

Dr Vines: Did you say 19 or 90?

Q66 Michael Fallon: 19. What do you estimate the debt to be at the moment-the total debt as a percentage of GDP? If you take all the non-performing loans and local government debt and central Government debt, what do you put it at, roughly?

Dr Yueh: As Kerry was suggesting, it is very difficult to work out because of the lack of accurate statistics on it. I can give you some of the ranges. If you take central Government debt, some calculations by scholars of local government debt, plus some of the liabilities of the state-owned banking sector, it is probably at least 60% of GDP, but it could well be higher. It is extremely difficult to estimate.

Q67 Michael Fallon: Do you have reliable statistics for the amount of lending to local government by state-owned banks?

Dr Yueh: These statistics are also extremely difficult to come by, and one of the things that the Chinese Government is doing now is that they are relaxing the ability of local government to independently issue bonds to help them manage their finances better, so they are not reliant on loans from local state-owned banks and land sales and that kind of thing.

Dr Vines: Which will be important, because the land sales thing has been terribly damaging.

Q68 Michael Fallon: Yes. How much control do they have over the level of that kind of bond issuance?

Dr Yueh: It had been the case that central permission was required and they are now experimenting with relaxing some of that to give localities more control over issuing Government bonds, and it is part of an overall effort both to have better fiscal management of the economy, but also to deepen capital markets, because bank lending is the predominant form of financing in the economy. They are trying to deepen capital markets, both in terms of Government and also corporate bonds, because that obviously will take some of the pressure off the banking system, which does come under pressure when you have times of economic stress. Deepening the capital markets has the added advantage of supporting all the other things that they wish to do with the currency.

Q69 Michael Fallon: Who stands behind the municipal bonds?

Dr Yueh: The issuing authority. If a local authority issues the bond that would be their responsibility, but let me emphasise that the fiscal system in China, in this respect, is under-developed.

Q70 Michael Fallon: Yes. You have mentioned the pressure on the banking system. Are they due a banking crisis at some point? Everybody else has had one. Isn’t it their turn?

Dr Brown: It is a bottomless pit, though. A guy in America, Victor Shih, did a lot of work on local government debt and he came out with colossal figures. The deal is I think the central Government wants the provincial leaders to keep a wrap on things. The kind of policy instruments they have used about housing, for instance, you referred to housing, you can only purchase two properties, you have limits on the amount of mortgage that you can take. These kinds of thing have calmed things down, but as economic actors people in China are very restricted. They have the stock exchange, they have property and then that is it. They can’t do much else. Just look at one area, pensions. Sichuan, they have all the money going with pensions. So where do they raise? They have to rely on a very cosy relationship with local state-run banks and it is a political decision whether they lend to state-owned enterprises. It is a consistent systemic problem, and it has been for 15 years.

Q71 Michael Fallon: What I am trying to get a handle on is, does the Government have as much control in total over the banking system as they pretend they have?

Dr Yueh: I think on some things, in terms of lending targets, we have seen that this is something that, on the big four state-owned banks, they have reasonable control; the local state-owned banks it is harder. On your question of a banking crisis, I am pretty sure this gets asked every couple of years and I think the issue here is the legacy of non-performing loans, the stock problem, and also a flow problem because it is still-

Dr Vines: That legacy has been dwindling over the last 10 years, hasn’t it?

Dr Yueh: It has. It has improved a great deal. However, the flow of state-owned enterprises still borrowing from state-owned banks, because they are inefficient, is an issue. I think one of the other things just to bear in mind is that, because of the way capital controls are imposed on the country, when they moved the bad debts off the balance sheets of the big four state-owned banks they are still within China itself in an asset management company. However, the big thing to think about is that, if the banking system needed help, does the Chinese Government have enough resources to help it? Therefore, recapitalising the banks should be the gauge as to whether or not, if the banks really did need capital, the Government can afford it. That is a key issue they constantly look at.

Dr Vines: Can I just add to that-the macroeconomist in me would say something-how difficult it is to avoid financial problems in the environment in which they find themselves? World interest rates much too low for China-the need for capital controls, which are disintegrating, to shield them from a wrong world interest rate with a currency that everyone knows in some way or other is undervalued. It is very hard to stop a property bubble happening in that environment and that is what we saw in the Asia crisis in the run up to 1997. I am not saying there will be one and the Chinese are very clever, but I am describing how difficult their task is at the moment.

Q72 Chair: Is there a document that you think we should all read to give us a guide on which statistics we should believe and which we should ignore?

Dr Yueh: This always sounds self-serving, but my latest book, published by Oxford University Press, Enterprising China: Business, Economic and Legal Developments Since 1979, has an extensive bibliography in the back with data sources that I use and other scholars that I cite draw on as well, if that is of some help to you.

Chair: That is very helpful and somewhat predictable.

Q73 Mark Garnier: The Chancellor, as you know, recently visited China and after that visit the CEO of the China Investment Corporation said that under the right circumstances China’s sovereign wealth fund would be enthusiastic to invest in the UK infrastructure. What do you think those right circumstances are?

Dr Yueh: One of the things that the sovereign wealth fund looks at-and this does reflect in overall Chinese policy that I mentioned before, which is pushing much more in terms of overseas investment-is the security of that investment. It is something perhaps we take for granted in Europe-actually, I am not going to go there-that your investment tends to be safe in a European country. They would want to diversify their holdings and part of the attraction of utilities is the regulated guaranteed return, and perhaps that was one of the attractions of Thames Water, but in terms of infrastructure that is another step. I think that would require, again, talking through which parts of it are-

Q74 Mark Garnier: I think this is where I am coming to because, as you said, there is infrastructure and infrastructure. For example, a pension fund-because, of course, this is something else that has been talked about here-might find investing in a utility distribution network-say, for example, the National Grid, where you had just one customer and one asset-quite a AAA-rated investment because it is all very simple, whereas with something like Thames Water or a water utility, of course, you have millions of consumers and lots more problems. What I am trying to get from you is, do you see them as looking for that AAA-rated distribution network type of infrastructure development or do you see them having slightly more AA-rated type of investment where you are looking at a utility with lots of customers?

Dr Brown: They have not been. You think of the way that, as an outward investor, the CIC-I think it was in 2007, though it existed before in a slightly different form-are very cautious. I always thought in 2007 when the economic crisis happened that if they were very opportunistic, despite political opposition in America, Europe would not be a bad place to come to. If you survey state-owned enterprise leaders, they say, "Yes, we want to invest more in Europe," yet it does not happen. It has been quite small. I think in the last five years there have only been 17 M&A in Europe.

Q75 Mark Garnier: Why is that so small?

Dr Brown: Wang Qishan, who is the Executive Vice-Premier for macroeconomy, made some comment a couple of years ago about, "Well, in Europe’s case, the barriers to entry for Chinese investors are big". It is 27 different jurisdictions. It is not unified. So the competence in fact, finally, for the European Union to have a unified investment policy is now with the Director-General of the Commission for Investment in Brussels, but that has only just happened. They have a pretty intimidating pathway, even when we are begging them to come and invest here. We have not begged them, obviously, but we have been saying, "Do come and invest here," for quite a while. It just has not happened. It is partly their cautiousness and partly the route is not so easy.

Q76 Mark Garnier: What you are essentially saying is they are a huge country and they are looking at Europe as one entity, but actually it is 27 separate entities, so it is not quite fitting into their investment model. Is that-

Dr Yueh: There are probably a couple of sides to this. One is, of course, the advantage of negotiating with 27 different countries-if you can’t get it from one, you could go to another. To answer your question about AAA versus AA+, the Chinese sovereign wealth fund will be a cautious investor. They have lost money, allegedly, during some investments in financial firms a few years ago, despite attractive valuations. I think what they would-

Dr Vines: They piled in early and lost money because they bought while the slide was continuing and I think they lost money doing that.

Dr Yueh: Yes. That generated political pressure within China on what the sovereign wealth fund was actually doing. They want to make the investment, but they will be cautious in terms of return. It is kind of the safety issue that I was describing.

Q77 Mark Garnier: They have been international investors for a relatively short amount of time. Is it partly because of their naivety, that they do not necessarily understand the concept of passive risk in terms of investing in other people’s-is this something that will develop as they become more experienced?

Dr Yueh: It is something they will develop as they become more experienced. Just to give you an idea of how fresh outward investment is, the very first commercial outward investment from China took place in 2003. A Chinese company, TCL, bought the Thomson brand from France. That is how recent it is. CIC is a recent investor as well. State-owned enterprises have invested for longer, but they invest with a different set of objectives, predominantly in commodity and resources.

Q78 Mark Garnier: That is not strictly true. You did have things like Shanghai International Trust and Investment Company from the late 1980s or early 1990s who famously lost $1 billion on-

Dr Yueh: State-owned enterprises, yes. That is right.

Q79 Mark Garnier: But also New York. I think they were trading commodity futures and they got that horribly wrong. They had a so-called rogue trader.

Dr Yueh: But you are talking about foreign direct investment. You are talking about investing in real assets.

Q80 Mark Garnier: Yes, absolutely.

Dr Yueh: This is what I mean by foreign direct investment. Of course, I suppose technically, if you take over 25% of a financial company it would be considered FDI, but in terms of thinking the strategy, yes.

Q81 Mark Garnier: You have been very clear. That makes a lot sense. Can I quickly turn to the other side of the Chancellor’s visit, which was the renminbi and having renminbi traded here? I have two questions. The first is do you think that is a good idea for this country and for China?

Dr Yueh: The answer there is yes. The move on the renminbi is to eventually make it a flexible and internationalised currency. There are a number of pressures on China, one of which is, of course, a peg to a very low interest rate country like the United States or the eurozone, in terms of the euro, means that it brings in too much liquidity because of the interest rate differential into the Chinese system. There is a move to make the renminbi itself used in international trade settlements, but the Chinese want to progress very cautiously on this. In July 2010 they set up Hong Kong as an offshore centre to begin to settle the renminbi in Hong Kong offshore.

The discussions with the Chancellor to move it to Britain is a big step in terms of internationalising it and using British expertise, because remember the British have a lot of expertise in doing this, and increasing the expertise and managing the currency done here so that it can be used in international trade. The amounts involved here are potentially very large. Analysts in Hong Kong say it could be as much as $2 trillion a year; looking of course at the total amount of Chinese trade therefore, denominated in that currency, that needs to be managed. This is potentially a very good, positive development.

Dr Vines: There is another interest in this, which is a sense that an objective, in the not too distant future, is to move to an international monetary system more generally that is not just dollar-based. It is difficult to run a currency system, but I think we are going there. I would just caution you in discussions with the Chinese. There is an element of Chinese thought that I have encountered recently that somehow thinks that if only the injustice of having an international monetary system that is denominated in dollars and then enables the US to, at the margin, spend without check were fixed, then somehow the problem of global imbalances would go away. I think you have to be aware of people who are pursuing what is a desirable objective for the financial system for what look like mistaken reasons.

Q82 Mr Love: I want you to speculate-I suspect that is the right word-on where you think global imbalances may be going in the future. Dr Vines, you said that you did not see global imbalances earlier on as being a problem. It was only as we approached 2007 and 2008 that they emerged. What we are concerned about is whether this will emerge again. You suggested that most economies, particularly China, act in their own self-interest rather than the wider economic interest. I think we have all decided that the G20 process or the IMF process does not have the sanctions within it to bring these economies into line.

Dr Vines: No, there is no stick in the system.

Q83 Mr Love: There is no stick in the system. What I wanted to ask you to do was just to say whether you think that acting in their own self-interest, as it looks like all of these economies will do-and there will be some move towards domestic demand rather than export-led demand-will be enough to stop global imbalances emerging as a major problem again and possibly the problem that it turned out to be?

Dr Vines: It is my worry-this is not a prediction-that in this next five, six, seven or eight-year period we will manage to prevent Europe exploding; we will recover gradually. It will begin to look dangerously like the "Greenspan Put" all over again, because it will be so gradual that interest rates will remain very low, near zero, for much too long and there will be near-bubbles turning up in wrong places. But in the end of this we face the risk that the dollar has not depreciated enough, that the US continue to have imbalances and-we have not talked about it at all-there is significant fiscal risk in the US of this long-term fiscal position not being corrected until there is a political crisis in that country. If in 2014 it still is not fixed-the projections I have heard from people can’t see how that will happen-and goes on another four years, there comes a point when there may be a real threat to the dollar. The thing that many people thought might happen in 2001 might turn out to happen 15 years later.

What we face if Germany does not adjust what is happening in Europe-these questions that we had earlier-if the Chinese rebalancing, moving carefully, cautiously, in the right direction, is slow and Asia is slow, the satisfactory but not wonderful recovery will be in the end sustained by Anglo-Saxon countries spending more than their long-run position will enable them to do, and we ask for a crisis that is a response to not having done this over the course of that period. It is not a prediction, but it is what we need to guard against.

Q84 Mr Love: You said earlier on, in the early years, although we had run imbalances in the UK and the US for years and years and years, they were not a problem. What emerged was the size to which those imbalances had grown in those final years up to 2000. Can that emerge again?

Dr Yueh: I worry that it could and one of the biggest drivers, which David began to raise, is because of the US fiscal problem. I call it that because the fiscal deficit in the United States was $1.3 trillion last year and it is projected to fall, if they can get their plans together, by 2015 and then it is projected to rise again unless they can reform entitlements. The implication of that, with a savings rate in the US that I believe right now is about 3.5% of household disposable income, implies that a current account deficit in the United States will be driven by the public borrowing of the United States Government.

Estimates here by economists in America suggest the US could run a 3% of GDP current account deficit in the coming years. It is half of what it was right before this last crisis, but it is larger than what it was in the previous decade. This is why the IMF also thinks that there is a chance that global imbalances could widen once again. That is one of my worries. The monitoring is about the consequences of excess liquidity and I would think on that front some of the savings changes in countries are also important just to think about.

Japan, which was on the other side of the ledger, has just run its very first annual trade deficit in 31 years, since 1980. It has an elderly population that is dis-saving, but corporations that save. As corporations also had a record year of investing overseas, you may begin to find that changing. China also has an ageing population, so in the coming years-remember the household savings rate, but that is only part of the issue-if firm savings begin to change because of greater outward investment and reforms, again that implies that some of the excess savings in those countries may begin to come down, but the implication of that could be to make Western borrowing more expensive.

That is probably the last thing I will say, which is, yes, global imbalances need to be rebalanced, but think about what that means. If you have a big deficit and you are issuing a great deal of Government debt, like in the United States, demand for that debt is one of the reasons why borrowing costs are so low. That plus the dollar’s reserve currency status are important determinants of whether or not global imbalances could be destabilising in the future.

Q85 Mr Love: Let me put an alternative view to you. You mentioned 1931 earlier on. Of course, we all came off the gold standard and then we had competitive devaluation with "beggar thy neighbour" policies pursued across the world. There is nobody suggesting that that is likely to emerge in the immediate term, but it could emerge in the slightly longer term, especially if we go back into recession again.

Dr Vines: Just imagine that, back into recession again.

Q86 Mr Love: You have already indicated about the problems they have in the United States in making policy decisions, partly as a result of some of these pressures. You mentioned the pressures in Southern Europe and reaction to the attitudes of the Germans, yet there is no overarching way in which the G20 or anyone else can impact on these. What policy prescriptions would you suggest that can address these so we cut off the problem before it becomes too serious?

Dr Vines: You are giving a speech at the Bretton Woods Conference in 1944 in what you say here. This is what they were seeking there. I am cautiously hopeful that the G20-wonderful London Summit, very important London Summit-followed by the moves to systematise this with the G20 MAP-what was done last summer in the work on the indicators that selected seven countries for careful study in the run up to Cannes, and that was sadly blown away by Europe so that the Cannes Summit did not consider properly the careful work that had been done. What I hear is that the Mexican Summit is not being carefully enough worked on so that in May we will not be able to make the considered decisions necessary.

Okay, you have missed six months to Cannes, you have missed another six months to May, but time goes on and the world, we hope, will not blow up in the next 18 months. So we now begin to have a framework in which there are no sticks but careful analysis and an obvious understanding by an international community of Sherpas and members of financial Ministries of what needs to be done. Working together is terribly important.

Q87 Chair: I am going to end in just a moment, but I am going to end with a question to Dr Brown. Do you think China, politically, can survive full globalisation and economic integration?

Dr Brown: I suppose the moment we know that is when they do internationalise the renminbi and then either we run for cover or they do. I guess my money is on them at the moment, but I do not think that they would-

Q88 Chair: What does running for cover mean if you are Chinese? Can this highly centralised system survive globalisation?

Dr Brown: I think the Communist Party of China has been very merciful to us in a way because it has held back a lot of very hungry economic actors who, I think, would have a massive impact on the global economy because of this firewall of the currency and, in a sense, it is a great restraint. In fact, I think once that is lifted, and maybe quite quickly, then the impact of having Chinese investors, Chinese investing on stock exchanges, it is going to be immense. It is going to be absolutely huge.

Q89 Chair: To be clear, you are just saying if we had a full revaluation of the renminbi and full convertibility we would not be able to cope with the investment flows that would pour over, buying all our assets? This would be a rerun of the Japan fear of the late 1970s and 1980s?

Dr Vines: I think you might be right.

Dr Brown: Yes. It is a lot of pent-up energy. On the one hand we want the investment involvement of China. On the other hand, we run like hell if they do put their hands up. It is very ambiguous, very contradictory, but in fact it seems to me the way that Chinese policymakers-their challenges-it is not in our terms. It is more about internal imbalances. They always look very worried, but it is not because of the mess outside. It is often because of the big challenges they face. They articulate their primary objectives in incredibly local ways and I think that that is something we have to engage with because their problems are our problems now.

Chair: I am going to end this session here, even though I know that everybody

wants to come in, largely because there is a great deal going on in the House this afternoon, not because we are not interested in what you are saying. I think you can gather we are very interested. We have had some reading recommendations from one of your number and I expect we will probably-

Dr Vines: I have sent you, Chairman, through Antonia Brown, a small document that came from a meeting in Seoul that I thought of.

Chair: Good. We will look forward to reading that.

Dr Vines: It was a meeting in Seoul of Asian and European macroeconomists, a briefing document for your trip that might be helpful.

Chair: Thank you. Thank you very much for coming this afternoon. We a

very grateful and we have learnt a lot in a short space of time.

Prepared 2nd February 2012