LibraryRed Capitalism The Fragile Financial Foundation of China´s Extraordinary Rise

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 MarketsChina’ 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, 1998How the National Team, Its Families and Friends BenefitA 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

Appen dix

Select Bibliography

Index

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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 wewanted 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 thatgets beyond the macroeconomics of things. We are the first to agree that living and working inthe 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 thecountry’ s economy. Having worked in banks for longer than we care to remember, we wanted totry to understand how China and its ruling class finance themselves and we knew we had to beginwith the banks since, in truth, they are China’ s financial system. Those looking for tales ofcorruption and princelings with their hands in the till will be disappointed though. We thinkthat the financial side of the story behind a 30-year boom that changed the lives of onebillion people is much more interesting; so this is our effort at staking out modern China’ spolitical 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 alsodo not believe in the recent triumphalism of China’ s bankers and many of its leaders; this isonly a diplomatic ploy. China’ s banks survived the global financial crisis, as one seniorbanker 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 of1997 and those sovereign-debt crises that have followed, China’ s political elite has nointention of exposing itself to international capital markets. The domestic economy and marketsare, 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 commodityinvestments that will neither be marked-to-market nor sold, why shouldn’ t the system survive amajor international crisis better than open economies? China’ s financial system is designed sothat 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 theclosure of small companies in 2008 and 2009. But China’ s banks were not exposed in anymaterial 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-ownedeconomy, are “inside the system. ” The private economy, no matter how vibrant, is “outsidethe system” and, in fact, serves at the will of the system. If nothing else, the events of thefall 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 theChinese officialdom these days. But is China’ s own financial system a model for the world tostudy? Can China be thought of as an economic superpower, either now or in the future, withsuch a system?

With this sort of question in mind, we began to look at the financial history of the People’ sRepublic of China. We were fortunate that 2008 was the thirtieth anniversary of China’ s highlysuccessful Reform and Opening Policy, so there were many excellent retrospectives prepared bythe government agencies. The People’ s Bank of China, in particular, produced very usefulmaterial, some of which took one of us back 30 years to Beijing University where his study ofChinese banks began. We hasten to emphasize that all the information used in writing this bookderives from purely public sources. In China, all of the important ministries, corporations andbanks maintain excellent websites, so data is just out there in the wind waiting to bedownloaded. In particular, China Bond and the National Association of Financial MarketInstitutional Investors (NAFMII) , a sub-set of the People’ s Bank, have extensive websitesproviding 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 theaudited financial statements of China’ s banks, all available online since the respectivelistings of each bank. Reading these statements has been highly educational. We stronglyencourage others, including China’ s regulators, to do the same.

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

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

We would like to thank those who have helped us think about this big topic, including in noparticular 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 VictorShih. Over the years we have grown to greatly appreciate our friends at John Wiley, startingwith Nick Wallwork, our publisher who kickstarted our writing career in 2003, Fiona Wong, JulesYap, Cynthia Mak and Camy Boey. Professionals all, they made working on this book easy andenjoyable. 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 wehave written here, however, remains our sole responsibility and reflects neither the views ofour 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 atStanford 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 andanything else we have done over the years in China might never have happened. We both continueto be very much in debt to our wives and families who have continued to at least tolerate ourcurious 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 thefinancial space, including trust companies and asset-transfer exchanges. May be next time.Beijing and Singapore

October 2010

List of Abbreviations

ABCAgricultural Bank of ChinaAMCasset-management companyBOCBank of ChinaCBRCChina BankingRegulatory CommissionCDBChina Development BankCGBChinese government bondCICChina InvestmentCorporationCPcommercial paperCSRCChina Securities Regulatory CommissionICBCIndustrial andCommercial Bank of ChinaMOFMinistry of FinanceMORMinistry of RailwaysMTNmedium-term notesNAVnet asset valueNDRCNational Development and Reform CommissionNPCNational People’ s CongressNPLnon-performing loanPBOCPeople’ s Bank of ChinaSAFEState Administration for Foreign ExchangeSASACState-owned Assets Supervision and Administration Commission