Fed Chairman Greenspan Takes Aim at Use of Capital Markets Leverage to Protect U.S. Security Interests — and Misses

(Washington D.C.): In a clearly orchestrated gambit, Sen. Phil Gramm
(R-TX) solicited
testimony in a Senate Banking Committee hearing today from Federal Reserve
Chairman Alan
Greenspan in the hope of sandbagging legislation that would create promising new
foreign
policy options in the fight against proliferation. Specifically, Greenspan inveighed against the
use proposed by Senators Fred Thompson (R-TN) and Robert
Torricelli (D-NJ) of access to
the U.S. capital markets to discourage the ongoing, egregious proliferation activities of select
Chinese companies, government-controlled entities and other global “bad actors.”

‘There You Go Again’

Chairman Gramm has made a career lately of seeking the evisceration of export
controls
and other economic sanctions as instruments of U.S. foreign policy. He has similarly
made
clear his determination to thwart the Thompson-Torricelli initiative. Toward that end, he led the
witness with the following set-up speech/question:

….You’re aware, we have spent years battling the effort by [the]American government
to use trade as a tool of foreign policy. Hardly anything is more denounced than export
controls, in terms of limiting the ability of our farmers to sell agricultural products or
our manufacturers to sell manufactured products, based on our approval or disapproval
of potential customers. And except for those pariah states where we have virtually a
state of war, in terms of our conflicts in foreign policy, we have gotten away from
using economic trade as a tool of foreign policy.

We now have a new proposal, as I’m sure you’re aware of, called the China
Non-proliferation Act, that was introduced by Senator Thompson, that seeks for the
first time to use access to our capital market and access to our banking system as
an instrument of American foreign policy.

The objectives of the bill are objectives that no one can disagree with, and that
is, we would like nations not to proliferate in terms of weapon sales.

But the tools that are being used represent, in my opinion, a very real threat to
our prosperity and finally, in posing the question, a paradox, in the sense that we
bargained harder in our relations with China, in the normal trade relation
agreements and the Chinese accession to WTO — we bargained harder to open
our access to our — the access our banking system and our investment system has
to the Chinese market than almost any other area.

Greenspan Responds — and the Casey Institute Sets the Record
Straight

The Fed chairman made three main points in response to Sen. Gramm’s softball:

1) Engagement will solve the proliferation — and other — ‘problems’ with
China:

Chairman Greenspan: As you know, my own view is
that our gradual increase in
engagement commercially with China is undermining many of the types of structures
which I think lead to the problems we have. And I think that contrary to engaging
them in less commercial activities, I think it’s very much to our advantage to
significantly increase involving them in free trade, open-market economics, and
basically the type of dynamics which raise standards of living, and I think ultimately
create significant changes in societies.

The Casey Institute supports “free trade” and “open-market
economics.” But to
believe that these mechanisms are solving — or can, by themselves, resolve —
China’s
ongoing proliferation of weapons of mass destruction and their long-range ballistic missile
and other delivery systems is not supported by the record.

Indeed, published reports — to say nothing of what U.S. intelligence knows —
establish that
China’s proliferation “dynamic” is proceeding, notwithstanding all the U.S. investment, trade
and other economic assistance going to the PRC. As the Washington Post
editorialized on 14
July 2000:

The question, then, is whether U.S. policy needs more teeth….China’s continuing
assistance to Pakistan’s weapons program in the face of so many U.S. efforts to talk
Beijing out of it shows the limits of a non-confrontational approach. Clearly, China
views certain missile-making projects abroad as vital to its national security strategy–vital
enough to trump some other economic and diplomatic interests. By the same
token, the United States should make clear that a certain amount of Chinese
missile-making is incompatible with business as usual.

2) Capital controls are undesirable.

Chairman Greenspan: In addition to questioning the
value of this amendment,
there’s a very serious question as to whether it will produce, indeed, what is suggested
it will produce. First, let me just say that the remarkable evolution of the American
financial system, especially in recent years, has undoubtedly been a major factor in the
extraordinary economy we’ve experienced. And it’s the openness and the lack of
political pressures within the system which has made it such an effective component
of our economy and, indeed, has drawn foreigners generally to the American markets
for financing as being the most efficient place where they can, in many cases, raise
funds.

The Casey Institute has made clear for the four years it has been
pursuing the
Institute’s Capital Markets Transparency Initiative (CMTI) that it is committed to the
preservation and prospering of America’s open capital markets and agrees with Chairman
Greenspan that our markets are pillars of U.S. global leadership and competitiveness.

As a result, the Institute has eschewed capital controls, undue government intervention and
other
measures which could impede the free flow of capital into and out of the United States in favor
of the market-oriented strengthening of disclosure and transparency requirements for foreign
entrants into our markets.

There are certain select circumstances, however, where the temporary denial of access to a
largely unwitting U.S. investor community is justified in order to protect overarching national
security interests and forestall the underwriting of egregious human rights abuses (e.g., genocide
and slave-trading in Sudan). In the case of the Thompson-Torricelli legislation, which is
reportedly going to be expanded to include North Korea and Pakistan, the stakes are nothing
short of the choice between thwarting or abetting proliferation — which President Clinton has
repeatedly determined to be the greatest threat the Nation faces.

3) They’ll Take Their Business Elsewhere — Cost-Free:

Chairman Greenspan: It is a mistake to believe that the
rest of the world is without
dissimilar resources. Indeed, there [are] huge dollar markets all over the world to lend
dollars. And because of the arbitrage that exists on a very sophisticated level
throughout the world, the interest rates and the availability of funds are not materially
different abroad than here. We do have certain advantages, certain techniques which
probably give us a competitive advantage, but they are relatively minor. But most
importantly, to the extent that we block foreigners from investing — for raising funds
in the United States, we probably undercut the viability of our own system.

But far more important is, I’m not even sure how such a law would be effectively
implemented, because there is a huge amount of transfer of funds around the
world. For example, if we were to block China, or anybody else, from borrowing
in the United States, they could very readily borrow in London and be financed
by American investors. Or if not in London — if London weren’t financed by
American investors, London could be financed, for example, by Paris investors,
and we finance the Paris investors.

In other words, there are all sorts of mechanisms that are involved here, and so
the presumption that somehow we can block the capability of China or anybody
else borrowing at essentially identical terms abroad as here, in my judgment, is a
mistake.

So my most fundamental concern about this particular amendment is it doesn’t
have any capacity, of which I am aware, to work. But being put in effect, the only
thing that strikes me as a reasonable expectation is it can harm us more than it
would harm others. And therefore, I must say, Mr. Chairman, I do join you in
your concerns about that amendment and I trust it would not move forward, even
though I respect the motives of Senator Thompson and understand where he’s
coming from, but trust that he will try to achieve his ends in a somewhat different
manner and a more effective way.

The Casey Institute: Surely, the Federal Reserve
chairman knows that the U.S. capital
markets are by far the world’s largest source of funds at the most competitive rates
available for international bond and equity offerings. Consequently, if foreign entities
were
to find themselves unable to access the American debt and equity markets, they would find it
difficult to attract, on an annual basis, the substantial funding needed and would likely pay a
premium for such funds as they can attract. These problems would only be
exacerbated if the
reason for such denial of access were on the grounds of national security or egregious human
rights concerns. In all likelihood, such a stigma would also not go unnoticed by rating agencies
(e.g., Moody’s, Standard and Poor’s, etc.)

As the Financial Times reported on 24 May 2000 in connection with the
groundswell of support
building behind the Thompson-Torricelli bill: “It reflects a growing body of opinion
that the
US should leverage the supremacy of its markets to help achieve its policy
goals.” (Emphasis
added.)

A Case in Point: PetroChina

Mr. Greenspan also seems to have missed the recent, real-world experience with a Chinese
concern that experienced this stigma: China National Petroleum Company (CNPC) and
its
contrived subsidiary, PetroChina. Thanks in large part to the efforts of an
extraordinarily
broad-based group of non-governmental public policy organizations known as the PetroChina
Coalition,⁽¹⁾ an initial public offering by CNPC/PetroChina
was delayed by months, dramatically
reduced in size (some 71% below its originally targeted amount of $10 billion) and greatly
increased in cost to the offerers.

Particularly noteworthy was the decision by large U.S. public pension and mutual
funds —
with some $1 trillion under management — to announce publicly their intention to forego
purchases of PetroChina stock due to social pressures, traditional financial concerns
and
intensified “due diligence” problems arising from the politically charged nature of this
transaction. As one would expect, such a decision also translated into an unwillingness on their
part to purchase such “radioactive” shares on overseas markets as well.

The Bottom Line

In sum, the picture painted at Sen. Gramm’s direction by Chairman Greenspan neither
recognizes
the requirement for additional foreign policy tools to address the burgeoning threat posed by
proliferation (not to mention other vital security and human rights concerns) nor properly
portrays the utility of putting transgressors in this area on notice that their access to the U.S.
capital markets could be jeopardized. It was a disservice to the highly regarded Federal
Reserve Board’s chairman to put him in a position whereby he was obliged to expend
valued political capital and personal credibility in opposing a national security and foreign
policy initiative that can work and is urgently needed.

– 30 –

1. See the Casey Institute Press Release entitled
Casey Symposium Affirms Emerging
Importance of Capital Markets Transparency, Leverage on Global ‘Bad Actors’
(No. 00-R 62,
29 June 2000).