What I’m Reading: Red Capitalism

At the moment China’s economy doesn’t look so good, but maybe it never did. 

Over the next few weeks I highlight what I learned about China by reading about it and visiting it in July 2015. With China’s economy in a state of turmoil (over significantly lower growth that still outstrips that of developed countries), some are beginning to question the fundamentals of the Chinese economy and the system around which it has been built. One of the books I read on my trip was Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise by Carl Walter and Fraser Howie, career bankers. At the moment, the authors are probably sitting back, watching all their warnings come to fruition. Here’s a cliffnotes of what they pointed out:

  • For a decade starting in the early 1990s, the Chinese economy was in a state of reform, shifting towards market-oriented policies.
  • China’s financial system is just…banks. The financial system is not developed like in the US, where there are large money markets, bond markets, stock markets, etc. In addition, banks  legally cannot charge more than 1 percent on loans above the interbank rate set by the People’s Bank of China. Because banks are state-owned (e.g. Agricultural Bank of China, Bank of China, Industrial and Commercial Bank of China), they frequently are simply under directives from the People’s Bank or the government in general; profit motives and the equilibrating movements of the market simply are not present in many cases.
  • The Chinese bond market illustrates how undeveloped Chinese finance is. There is hardly any trading; the authors show it. Businesses don’t raise capital by issuing bonds like they do in the States; they are almost entirely reliant on bank loans. If anything happens to the banks, of course, the system is in trouble.
  • China has just a bunch of toxic assets just floating around. The authors describe a complex system of moving around a large number of non-performing loans from balance sheet to balance sheet, without ever writing them off. The Party, they argue is simply unwilling to just suffer the cost and move on.
  • The China Investment Corporation (CIC), a sovereign wealth fund, isn’t…well, a sovereign wealth fund. In fact, after the government created it, it went on to spend two-thirds of its new capital on recapitalizing domestic banks. Looking at it now, it now has over half a trillion dollars in assets.
  • There is some discord among economic policymakers. There seem to have been some turf battles between the People’s Bank of China and the Ministry of Finance, such as when the PBOC took over certain banks and the creation of the CIC. Bureaucracy definitely a problem.
  • The Chinese stock market doesn’t really mean anything. Though there may be a lot of money in it, the authors make an important point that stocks, which generally imply or confer ownership of a company, can’t have significance in a country where there is technically no such thing as ownership. A stock listed on the Shanghai Exchange, they argue, cannot be anywhere near the same as one listed on the NYSE. The whole motivation behind creating the market in the first place, it seems, was to put on the face of a modern economy. In fact, apparently American investment banks were key to transforming Chinese firms into entities that could be listed on something called a stock market. China Telecom, for example, was largely the work of Goldman Sachs.
  • Author critique: I always like to look critically at the author of a text for biases. In this case, the authors are probably biased against the entire Chinese system, regardless of what works and what doesn’t, for they never relented in their criticism (and surely, there’s a lot to criticize). But I also think that they themselves are maybe unhappy with having to navigate such a system, that their own banks may have not made as much money as they could have, like so many foreigners before them hindered from maximizing profit in the Middle Kingdom.

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