Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise Read online

  Contents

  Preface

  List of Abbreviations

  Chapter 1 : Looking Back at the Policy of Reform and Opening

  Thirty Years of Opening up: 1978–2008

  Thirteen Years of Reform: 1992–2005

  The End of Reform: 2005

  China is a Family Business

  Endnotes

  Chapter 2 : China’s Fortress Banking System

  Banks are China’s Financial System

  Crisis: The Stimulus to Bank Reform, 1988 and 1998

  China’s Fortress Banking System in 2009

  The Sudden thirst for Capital and Cash Dividends, 2010

  Endnotes

  Chapter 3 : The Fragile Fortress

  The People’s Bank of China Restructuring Model

  The Ministry of Finance Restructuring Model

  The “Perpetual Put” Option to the PBOC

  China’s Latest Banking Model

  Implications

  Endnotes

  Chapter 4 : China’s Captive Bond Market

  Why does China have a Bond Market?

  Risk Management

  The Base of the Pyramid: “Protecting” Household Depositors

  Endnotes

  Chapter 5 : The Struggle over China’s Bond Markets

  The CDB, the MOF and the Big 4 Banks

  Local Governments Unleashed

  China Investment Corporation: Lynchpin of China’s Financial System

  Cycles in the Financial Markets

  Endnotes

  Chapter 6 : Western Finance, SOE Reform and China’s Stock Markets

  China’s Stock Markets Today

  Why does China have Stock Markets?

  What Stock Markets gave China

  Endnotes

  Chapter 7 : The National Team and China’s Government

  Zhu Rongji’s Gift: Organizational Streamlining, 1998

  How the National Team, Its Families and Friends Benefit

  A Casino or a Success, or Both?

  Implications

  Endnotes

  Chapter 8 : The Forbidden City

  The Emperor of Finance

  Behind the Vermillion Walls

  An Empire Apart

  Cracks in the Walls

  Imperial Ornaments

  Endnotes

  Appendix

  Select Bibliography

  Index

  Copyright © 2011 John Wiley & Sons (Asia) Pte. Ltd.

  Published in 2011 by John Wiley & Sons (Asia) Pte. Ltd.

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  To John Wilson Lewis

  Preface

  After three rounds of Privatizing China, our book about China’s stock markets, we felt like we wanted to look into something new. Since we took our first look at the stock markets in 1999, we have been interested to note the lack of work on the financial side of China’s miracle that gets beyond the macroeconomics of things. We are the first to agree that living and working in the country for 25 years may not qualify us as experts in economics. We do believe, however, that our experience has given us a feel for how China’s political elite manages money and the country’s economy. Having worked in banks for longer than we care to remember, we wanted to try to understand how China and its ruling class finance themselves and we knew we had to begin with the banks since, in truth, they are China’s financial system. Those looking for tales of corruption and princelings with their hands in the till will be disappointed though. We think that the financial side of the story behind a 30-year boom that changed the lives of one billion people is much more interesting; so this is our effort at staking out modern China’s political economy “inside the system.”

  We do not believe in Chinese exceptionalism. China’s economy is no different from any other, in spite of the inevitable Chinese characteristics. If there are such things as economic laws, they work just as well in China and for Chinese businesses as they do in other markets. We also do not believe in the recent triumphalism of China’s bankers and many of its leaders; this is only a diplomatic ploy. China’s banks survived the global financial crisis, as one senior banker has publicly stated, simply because the financial system is closed off from the world. Having seriously studied the collapse of Mexico’s peso in 1994, the Asian Financial Crisis of 1997 and those sovereign-debt crises that have followed, China’s political elite has no intention of exposing itself to international capital markets. The domestic economy and markets are, and will continue to be, most deliberately closed off. With a non-convertible currency, minimal foreign participation and few overseas assets beyond US Treasuries and commodity investments that will neither be marked-to-market nor sold, why shouldn’t the system survive a major international crisis better than open economies? China’s financial system is designed so that no one is able to take a position opposite to that of the government.

  Of course, the private export-oriented sector suffered massive losses in jobs, earnings and the closure of small companies in 2008 and 2009. But China’s banks were not exposed in any material way to this sector. It is a simple fact that China’s financial system and its stock, bond and loan markets cater only to the state sector, of which the “National Champions” represent the reddest of the Red. These corporations, the heart of China’s state-owned economy, are “inside the system.” The private economy, no matter how vibrant, is “outside the system” and, in fact, serves at the will of the system. If nothing else, the events of the fall of 2008 added an additional seal to the Party’s determination to sustain a closed, tightly controlled, economy. “Don’t show me any failed models,” is the refrain
of the Chinese officialdom these days. But is China’s own financial system a model for the world to study? Can China be thought of as an economic superpower, either now or in the future, with such a system?

  With this sort of question in mind, we began to look at the financial history of the People’s Republic of China. We were fortunate that 2008 was the thirtieth anniversary of China’s highly successful Reform and Opening Policy, so there were many excellent retrospectives prepared by the government agencies. The People’s Bank of China, in particular, produced very useful material, some of which took one of us back 30 years to Beijing University where his study of Chinese banks began. We hasten to emphasize that all the information used in writing this book derives from purely public sources. In China, all of the important ministries, corporations and banks maintain excellent websites, so data is just out there in the wind waiting to be downloaded. In particular, China Bond and the National Association of Financial Market Institutional Investors (NAFMII), a sub-set of the People’s Bank, have extensive websites providing access to information, in both Chinese and English, on China’s fixed-income markets. Data for the stock markets have always been plentiful and, we believe, accurate. Again, Wind Information, China’s Bloomberg equivalent, has been a rich source for us. Then, there are the audited financial statements of China’s banks, all available online since the respective listings of each bank. Reading these statements has been highly educational. We strongly encourage others, including China’s regulators, to do the same.

  So the modern age of technology provided all the dots that, linked together, present a picture of the financial sector. How they are connected in this book is purely the authors’ collective responsibility: the picture presented, we believe, is accurate to the best of our professional and personal experience. We hope that this book will, like Privatizing China, be seen as a constructive outsiders’ view of how China’s leadership over the years has put together what we believe to be a very fragile financial system.

  For all the fragility of the current system, however, one of us is always reminded that his journey in China began in Beijing back in 1979 when the city looked a lot like Pyongyang. With North Korea in the headlines again for all the wrong reasons, it is worth remembering and acknowledging the tremendous benefits the great majority of Chinese have reaped as a result of the changes over the past 30 years. This can never be forgotten, but it should also not be used as an excuse to ignore or downplay the very real weaknesses lying at the heart of the financial system.

  We would like to thank those who have helped us think about this big topic, including in no particular order Kjeld Erik Brosdgaard, Peter Nolan, Josh Cheng, Jean Oi, Michael Harris, Arthur Kroeber, Andrew Zhang, Alan Ho, Andy Walder, Sarah Eaton, Elaine La Roche and Victor Shih. Over the years we have grown to greatly appreciate our friends at John Wiley, starting with Nick Wallwork, our publisher who kickstarted our writing career in 2003, Fiona Wong, Jules Yap, Cynthia Mak and Camy Boey. Professionals all, they made working on this book easy and enjoyable. John Owen was an unbelievably quick copyeditor and Celine Tng, our proofreader, gave “detail-oriented” a whole new definition! We thank you all for your strong support. What we have written here, however, remains our sole responsibility and reflects neither the views of our friends and colleagues, nor those of the organizations we work for.

  We have dedicated the book to John Wilson Lewis, Professor Emeritus of Political Science at Stanford University. John was the catalyst for Carl’s career in China and, indirectly, Fraser’s as well. Without his support and encouragement, it is fair to say that this book and anything else we have done over the years in China might never have happened. We both continue to be very much in debt to our wives and families who have continued to at least tolerate our curious interest in Chinese financial matters. We promise to drop the topic for a while now, even though we are well aware that there remains much that needs to be looked at in the financial space, including trust companies and asset-transfer exchanges. May be next time.

  Beijing and Singapore

  October 2010

  List of Abbreviations

  ABC Agricultural Bank of China

  AMC asset-management company

  BOC Bank of China

  CBRC China Banking Regulatory Commission

  CDB China Development Bank

  CGB Chinese government bond

  CIC China Investment Corporation

  CP commercial paper

  CSRC China Securities Regulatory Commission

  ICBC Industrial and Commercial Bank of China

  MOF Ministry of Finance

  MOR Ministry of Railways

  MTN medium-term notes

  NAV net asset value

  NDRC National Development and Reform Commission

  NPC National People’s Congress

  NPL non-performing loan

  PBOC People’s Bank of China

  SAFE State Administration for Foreign Exchange

  SASAC State-owned Assets Supervision and Administration Commission

  CHAPTER 1

  Looking Back at the Policy of Reform and Opening

  “One short nap took me all the way back to before 1949.”

  Unknown cadre, Communist Party of China

  Summer 2008

  It was the summer of 2008 and the great cities of eastern China sparkled in the sun. Visitors from the West had seen nothing like it outside of science fiction movies. In Beijing, the mad rush to put the finishing touches on the Olympic preparations was coming to an end—some 40 million pots of flowers had been laid out along the boulevards overnight. The city was filled with new subway and light-rail lines, an incomparable new airport terminal, the mind-boggling Bird’s Nest stadium, glittering office buildings and the CCTV Tower! Superhighways reached out in every direction, and there was even orderly traffic. Bristling in Beijing’s shadow, Shanghai appeared to have recovered the level of opulence it had reached in the 1930s and boasted a cafe society unsurpassed anywhere in Asia. Further south, Guangzhou, in the footsteps of Shanghai Pudong, was building a brand new city marked by two 100-storey office, hotel and television towers, a new library, an opera house and, of course, block after block of glass-clad buildings. Everyone, it seemed, was driving a Mercedes Benz or a BMW; the country was awash in cash.

  In the summer of 2008, China was in the midst of the hottest growth spurt in its entire history. The people stirred with righteous nationalism as it seemed obvious to all that the twenty-first century did, in fact, belong to the Chinese: just look at the financial mess internationally! Did anyone even remember the Cultural Revolution, Tiananmen, or the Great Leap Forward? In a brief 30 years, China had rejected communism, created its own brand of capitalism and, as all agreed, seemed poised to surpass its great model, the United States of America, the Beautiful Country. Looking around at China’s coastal cities bathed in the light of neon signs advertising multinational brands, their streets clogged with Buicks and Benzes, the wonder expressed by the confused Party cadre’s comment—“One short nap took me all the way back to before 1949”—can be well understood. In many ways, the past 30 years in China have seen a big rewind of the historical tape-recording to the early twentieth century.

  The West, its commentariat and investment-bank analysts all saw this as a miracle because they had never expected it. After all, 30 years ago China was barely able to pull itself off the floor where it had been knocked flat by the Cultural Revolution. Beijing in 1978 was a fully depreciated version of the city in 1949 minus the great city walls, which had all been torn down and turned into workers’ shanties and bomb shelters. When the old Quotations from Chairman Mao billboards were painted over in 1979, one new one depicted a Chang An Avenue streaming with automobiles: cyclists glanced in passing and pedaled slowly on. Shanghai, the former Pearl of the Orient, was frozen in time and completely dilapidated, with no air-conditioning anywhere and people sleeping on the streets in the torrid summer heat. Shenzhen was a rice paddy and Guangzhou a moldering ruin
. There was no beer, much less ice-cold beer, available anywhere; only thick glass bottles of warm orange pop stacked in wooden crates.

  THIRTY YEARS OF OPENING UP: 1978–2008