National Finance

Foreword

“National Finance” is a new subject of study in the field of finance. Different from the commonly referred to finance discipline which is studies about financial affairs in general, national finance focuses on the most essential and immediate issues pertaining to a country’s financial development. Such issues include the following aspects: after a country designs its top-​level financial layout and chooses a regulatory regime, how should it lead its domestic finance to develop and overtake facing the task of establishing a sound relationship between the central and the local, the difficulties involved in offshore and onshore financial development, and the rise of the financial strength of countries around the world? How should a country’s financial system respond to the worldwide rapid development of hi-​techs such as “artificial intelligence +​ blockchain”? How to guard against and cope with systemic or regional financial risks since security, liquidity, and profitability are the eternal cornerstones of a country’s finance? How should a country participate in the construction and promotion of a new international financial order amid international financial powers? These are all the questions that national finance as a subject must address at the highest level.

Western countries, notably the U.S., while making every effort to advocate theories of a laissez-​faire economy, frequently and unsparingly resort to financial measures at the national level. While there’s such obvious contradictions between words and actions in the western world, this book takes a clear-​cut stand that the top-​level layout of national finance should be optimized in the following five aspects: (i) faced with the contention of whether national financial system development is to be bank-​oriented or capital market–​oriented, with valid arguments on both sides each sticking to their own views, the national financial system should choose a direction and position itself clearly according to the actual conditions of the country; (ii) a complete modern financial market framework should be built and it should comprise the following six components: factors, organization, legalization, regulation, environment, and infrastructure; (iii) considerations should be made from the vantage point of the “Big Finance” concept when decision is made concerning where the “anchor” of a country’s monetary policy is to be placed, and then the objectives of national monetary policy as well as the selection and application of policy instruments should be adjusted on a timely basis to cater to the needs of national industrial policy and be effectively coordinated with the fiscal policies, exchange rate policies, and regulatory policies for these policies to play their due role; (iv) in considering and formulating national financial policies, a country should carefully analyze the short-​term, medium-​term, and long-​term advantages and disadvantages of adopting the national policy of a strong currency and seize the opportunity to advance such a policy when the time is right and the conditions are favorable; and (v) the materialization of the above four aspects requires the setup of an institution at the national level empowered to take charge of and coordinate national financial affairs, an institution that will have significant impact on major decisions concerning the national financial system and its future development. Of the five aspects, the first and the second are about financial concepts, the third and the fourth are about approaches, and the fifth is about institutions.

Among the above-​mentioned issues to be discussed in this book, I would like to emphasize the importance of a modern financial regulatory system. Globally speaking, the existing financial regulatory systems fall roughly into three categories: the single regulatory regime, the multiple regulatory regime, and the twin peaks regulatory regime. The twin peaks regulatory regime features strict separation between functional regulation and conduct regulation as well as organic integration of macro-​prudential regulation and micro-​prudential regulation. Moreover, it entails the setup of a financial policy committee, or a financial stability and development committee, on the basis of the existing monetary policy committee of the central bank, to allow effective handling of affairs regarding national financial regulation and development. If after weighing the pros and cons a country decides to adopt the twin peaks regulatory system, it must pay attention to the following important points: (i) the financial stability and development committee should be able to implement the top-​level policies of national finance with clear-​cut responsibilities and powers; (ii) the responsibility and power division between the financial stability and development committee, the functional regulation office and the conduct regulation office should be clearly defined; and (iii) the responsibility and power division, the interaction and coordination mechanism between macro-​prudential regulation and micro-​prudential regulation and between functional regulation and conduct regulation should be clearly defined.

Vertically speaking, the regulation over national financial development requires a demarcation of responsibilities and powers between the central and local levels. “Financial liberalization” directly brings about financial instability at the national level, and “financial repression” leads to financial stagnancy at the local level. To enable finance to better serve the development stage the country is in and the actual conditions of the country’s economic, financial, technological, and industrial development, the respective financial responsibilities and powers of central and local governments should be clearly defined and their respective positive roles be given full play, so as to form a unified, yet flexible, and free, yet orderly, landscape. This necessitates the formulation of detailed rules specifying the relations between the central government and the financial regulatory branches it assigns to the local and the making of clear coordinative mechanisms, contents, and measures between such centrally assigned local financial regulatory branches and the local financial regulatory authorities. Only in this way can we promote economic development while exercising rigid control over financial risks.

Horizontally speaking, the regulation over national financial development demands an interactive connection between offshore and onshore finance. To establish such an interactive connection, in the early 1980s, the U.S. Federal Reserve Board opened a special account called International Banking Facilities (IBFs) which granted preferential rights and interests to domestic and foreign banks using the account, thus realizing convenient offshore and onshore connection of the U.S. dollar. In 1986, Japan set up the Japan Offshore Market (JOM) special account and designated an area in Tokyo as the onshore transaction and settlement center for the offshore market, thereby realizing offshore and onshore interaction of the Japanese yen. Laws, regulations, policies, and measures for offshore and onshore interconnection are of particular importance for the internationalization of a national currency, that is, the process of the currency shifting from a payment and settlement currency to a reserve currency and then to an anchor currency. The globalization of the RMB into an international reserve currency requires and will be expedited by the establishment of offshore and onshore interconnection accounts as well as by Hong Kong SAR, China acting as the bridgehead of the RMB offshore center and strengthening its connections with Singapore and London.

The world financial market is the battlefield of global financial superpowers, and a country needs matching factors and capabilities to corner overtake, with the main factors being bulk commodity trading and energy trading and the main capability being the ability to seize opportunities offered by good timing and favorable conditions. The rise of the British economy in the 18th and 19th centuries was largely due to the binding of coal trading to the British pound for settlement, which enabled the pound to gain an upper hand over the Dutch guilder then dominating in the region and become a major world currency. After World War II, the U.S. seized the opportunity and bound oil trade with the U.S. dollar for settlement, enabling the dollar to defeat the pound at one stroke to become and remain so far the reigning currency for international transaction settlement and reserve. Subsequent to coal and oil, carbon emissions trading has shaped another field of bulk energy trading. China is one of the largest carbon emitters in the world with emissions estimated to reach their peak between 2020 and 2030. It is time that China start to build a standardized carbon emissions trading market, improve carbon emissions spot market, develop carbon emissions futures market, and take faster steps in binding carbon emissions trading with the RMB for settlement, which will allow settlement scope of the RMB to cover Southeast Asia and even Asia and then blanket the entire globe. This offers an optimal way for China to corner overtake in its RMB internationalization and turn into reality the famous Nobel Prize in Economics winner professor Robert Mundell’s conception on the world monetary system, that is, the U.S. dollar, the euro and the RMB acting as the three islands of monetary stability.

The U.S. dollar still occupies a dominating position in the international monetary system and the RMB accounts for slightly over 2% of the international reserve currency. Whether the world monetary system dominated by the U.S. dollar will be shaken is contingent upon the development direction and comparative strength of the dollar, the euro, and the RMB in the future. Three prospects could be seen for the future development of the international monetary system: (i) the emergence of a single super-​sovereign currency; (ii) a common international Special Drawing Right (SDR) currency, whose value shall be determined by the current exchange rate of a basket of currencies composed of the U.S. dollar, the euro, the RMB, the Japanese yen, and the British pound; and (iii) a new global standard digital currency that takes the place of sovereign currencies as a super-​sovereign currency. The first prospect is practically impossible for the lack of a “world government” to enforce it, and the chances of SDR becoming an international currency are also slim due to the huge interests of sovereign currency countries at stake. This leaves the third prospect the only one that’s possible. With the rapid development of world science and technology, “AI +​ blockchain” technology is expected to give birth to a new global standard digital currency which will have subversive impact and become a legal digital currency. The right course of action in response to the development of Internet finance would be to, on the one hand, speed up the establishment of an effective settlement system, legal system, and risk prevention and control system for Internet finance, and, on the other hand, make good use of this important juncture in the standardized development of Internet finance and its intellectual property protection, and promote “AI +​ blockchain” technology so as to facilitate the emergence, promotion, and application of the legal digital currency.

Besides building an international monetary system, another challenge facing all countries is to prevent financial risks. To prevent, mitigate, and deal with financial risks is always the number one mission of any country’s financial system. The U.S. in particular has, from its experience of dealing with multiple international financial crises, found a way of combining monetary policies with fiscal policies, regulatory policies, laws and regulations, and plans comprising a package of economic revitalization measures to resolve crises, help sectors, and revitalize industries. The U.S. experience is worth learning from for other countries.

The trend of global economic integration and the internationalization of financial market means the call for a sound and stable international financial system has become ever more urgent. The building of such an international financial system requires the internationalization of financial markets, financial instruments, and financial participants, as well as the internationalization of the rules governing financial activities, of financial regulation, and of financial risk prevention and control. These are all challenges the national financial system of all countries will inevitably have to confront.