In China, so much of it now looks so familiar, so normal, so “West”. Yet, if one walks behind the scenes, peers through the windows of the many vacant buildings, and opens the financial books, a queasy feeling begins to develop in the pit of the stomach. In Michael Crichton’s 1973 movie, WESTWORLD, people paid to play out their Old West fantasies on a movie set. Today, it is looking like westerners may be playing out their financial fantasies in China. What investors perceive as familiar, be they architectural or financial structures may indeed be elaborate props constructed by the Chinese to deceive the West…and perhaps themselves.
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Recent articles in the ECONOMIST and the WALL STREET JOURNAL reveals a quickening pulse of concern in the banking and securities world: “Auditors Sharpen Queries in China”, “China Curbs Sales of Risky Wealth Management Products”, “Buffett-backed China Venture Falters”, “How China’s Banks Break the Rules”, “How Manageable is China’s red Ink?”, ”How real is China’s growth?”, “China; Rising power, anxious state”. All these headlines sound a sour note in the previous optimistic tune about the “Chinese Economic Miracle”. Suddenly it seems both regulators and investors are starting to hum a different tune… “How long has this been going on?” So what has been going on behind the scenes?
Seduction. A feeling of comfort is essential, be it in the bedroom or the board room, and here the Chinese have placed all the props to make global investors feel right at home. Messrs. Carl Walker and Fraser Howe, authors of the excellent book, RED CAPITALISM describe, “[It] involves a picture that outside observers…feel comfortable with since it makes China resemble other emerging markets.” [Italics added]. “[This includes] developed stock and debt-capital markets, a mutual funds industry, pension funds, sovereign-wealth funds, currency markets, foreign participation, an international central bank, home loans and credit cards, a burgeoning car industry and a handful of brilliant cities.” Thus, as the authors point out, it looks like the West! So it is easy for investors to be both stimulated yet at ease.
Certainly the crowded streets, busy commercial buildings, and humming factories are not all there just for some director to yell “Action” whenever westerners arrive. But the point is; only an estimated 2% of the debt that is financing all this growth and activity is held by foreign banks. Indeed, even accounting for the raising of capital in the stock markets, still 70% of the invested capital is done by the Chinese government itself. In other words, investment risks are not widely distributed as in more developed equity markets but instead China itself is the single most vulnerable to defaults.
While we are on the subject of banks, let’s take a quick look at China’s Big (an only) Four. As the 20th Century came to a close and the China was having one of its ten-year cyclical deep recessions, the banks were left with a whole pile of bad debts on its ledgers. Oh what to do? Hey gang, here’s a great idea! Let’s form four “Bad Banks”, transfer all that bad paper from the four national banks, thus reburnishing the balance sheets and make them the “Good Banks”, then sell equities on the global markets for these bright shining examples of Communist Capitalism.
Recently the SEC has suspended trading on about a dozen or so stocks with connections to China. There has been a recent trend for “reverse mergers”, where Chinese companies have purchased and “merged” with American companies traded on Wall Street. Concerns are being raised that regulators are not confidently able to audit the auditors of those Chinese investors and holdings. Terms such as “Ponzi Scheme” are now being used as Canadian-listed Sino-Forest shares dropped from 18.21 Canadian dollars to 3.19 as short-sellers circled in for the kill. Nine Dragons Paper, controlled by China’s richest woman (Zhang Yin, worth US$5.6 billion) had its Standard and Poor’s rating withdrawn.
Mdm. Zhang, the daughter of a Red Army officer with good contacts within the Chinese government, is a perfect example of what the Chinese refer to as “The Princelings”. This next generation is succeeding the old ruling elite who earned their bones in Mao’s Long March and is now taking over the full reins of governing.
This whole topic of the Princelings, the rapidly expanding and modernizing military, and China’s growing bellicosity as it looks to the South China Sea and yells, “Everybody, out of the pool!” are fascinating topics covered elsewhere on this website and in my current writings and lectures. Stay tuned.
Now, after having had a glimpse behind the Bamboo Curtain, to paraphrase Groucho Marks, “Who are you going to believe, them, or your own eyes?”
A very readable yet detailed book on the Chinese financial system.
Open link, read book summary with Q&A of authors. Very brief and very informative.
By Richard McGregor; This Amazon link also has a good summary and excellent insight into the irredeemable institutional corruption of China’s rule.
This YouTube video is of a recently built city, beautiful residential area, high-rise condos, and wide avenues, built for one million. It is not really deserted because it has never been occupied! If you are not a regular viewer of Qatar’s Al Jazeera TV, you may be impressed by the quality of this reporting.
It would seem that in this jet Age, Western constucts of reality have been on a Slow Boat to China.