Modern history

List of Abbreviations


Agricultural Bank of China


asset-management company


Bank of China


China Banking Regulatory Commission


China Development Bank


Chinese government bond


China Investment Corporation


commercial paper


China Securities Regulatory Commission


Industrial and Commercial Bank of China


Ministry of Finance


Ministry of Railways


medium-term notes


net asset value


National Development and Reform Commission


National People’s Congress


non-performing loan


People’s Bank of China


State Administration for Foreign Exchange


State-owned Assets Supervision and Administration Commission


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.


As a counterpoint to the Olympics and 2008, Deng Xiaoping, during his first, brief, political resurrection in 1974, led a large Chinese delegation to a special session of the United Nations. This was a huge step for China in lifting the self-imposed isolation that prevailed during the Cultural Revolution. Just before departing for New York, the entire central government, so the story goes, made a frantic search through all the banks in Beijing for funds to pay for the trip. The cupboard was bare: they could scrape together only US$38,000.1 This was to be the first time a supreme leader of China, virtually the Last Emperor, had visited America; if he couldn’t afford first-class international travel, just where was the money to support China’s economic development to come from?

How did it all happen, because it most certainly has happened? How were these brilliant achievements of only one generation paid for? And the corollary to this: what was the price paid? Understanding how China and its Communist Party has built its own version of capitalism is fundamental to understanding the role China will play in the global economy in the next few years. The overall economics of China’s current predicament is well understood by international economists, but the institutional arrangements underlying its politics and economics and their implications are far less understood. This book is about how institutions in China’s financial sector—its banks, local-government “financing platforms,” securities companies and corporations—affect the country’s economic choices and development path. Of course, behind these entities lies the Communist Party of China and the book necessarily talks about its role as well.

Prior to the Lehman shock of September 2008, the trajectory China’s financial development had been tracing generally followed a well-established path taken by more advanced economies elsewhere in the world. This approach was not easily adopted by a political elite that had been devastated by its own leaders for nearly 20 years and then suffered a further shock in 1989. The general story, however, has become the Great China Development Myth. It begins with the death of Mao in 1976 and the second restoration of Deng Xiaoping two years later. These events freed China to take part in the great financial liberalization that swept the world over the past quarter-century (see Figure 1.1). Looking back, there is no doubt that by the end of the 1980s, China saw the financial model embodied in the American Superhighway to Capital as its road to riches. It had seemed to work well for the Asian Tiger economies; why not for China as well? And so it has proven to be.

FIGURE 1.1 Thirty years of reform—trends in regulation


Source: Based on comments made by Peter Nolan, Copenhagen Business School, December 4, 2008

In the 1990s, China’s domestic reforms followed a path of deregulation blazed by the United States. In Shenzhen, in 1992, Deng Xiaoping resolutely expressed the view that capitalism wasn’t just for capitalists. His confidence caused the pace of reform to immediately quicken. China’s accession to the World Trade Organization in 2001 perhaps represented the crowning achievement in the unprecedented 13-year run of the Jiang Zemin/Zhu Rongji partnership. When had China’s economy ever before been run by its internationalist elite from the great City of Shanghai? Then, in 2003, the new Fourth Generation leaders were ushered in and things began to change. There was a feeling that too few people had gotten too rich too fast. While this may be true, the policy adjustments made have begun to endanger the earlier achievements and have had a significant impact on the government itself. The new leadership’s political predisposition, combined with a weak grasp of finance and economics, has led to change through incremental political compromise that has pushed economic reform far from its original path. This policy drift has been hidden by a booming economy and almost-continuous bread and circuses—the Olympics, the Big Parade, the Shanghai World Expo and Guangzhou’s Asian Games.

The framework of China’s current financial system was set in the early 1990s by Jiang and Zhu. The best symbols of its direction are the Shanghai and Shenzhen stock exchanges, both established in the last days of 1990. Who could ever have thought in the dark days of 1989 that China would roll out the entire panoply of capitalism over the ensuing 10 years? In 1994, various laws were passed that created the basis for an independent central bank and set the biggest state banks—Bank of China (BOC), China Construction Bank (CCB), Industrial and Commercial Bank of China (ICBC) and Agricultural Bank of China (ABC)—on a path to become fully commercialized or, at least, more independent in their risk judgments and with strengthened balance sheets that did not put the economic and political systems at risk.

Reform was strengthened as a result of the lessons learned from the Asian Financial Crisis (AFC) in late 1997. Zhu Rongji, then premier, seized the moment to push a thorough recapitalization and repositioning of banks that the world at the time rightly viewed as more than “technically” bankrupt. He and a team led by Zhou Xiaochuan, then Chairman and CEO of the China Construction Bank, adopted a well-used international technique to thoroughly restructure their balance sheets. Similar to the Resolution Trust Corporation of the US savings-and-loan experience, Zhou advocated the creation of four “bad” banks, one for each of the Big 4 state banks. In 2000 and again in 2003, the government stripped out a total of over US$400 billion in bad loans from bank balance sheets and transferred them to the bad banks. It then recapitalized each bank, and attracted premier global financial institutions as strategic partners. On this solid base, the banks then raised over US$40 billion in new capital by listing their shares in Hong Kong and Shanghai in 2005 and 2006. The process had taken years of determined effort. Without doubt, the triumphant listings of BOC, CCB, and ICBC marked the peak of financial reform, and it seemed for a brief moment that China’s banks were on their way to becoming true banking powerhouses that, over time, would compete with the HSBCs and Citibanks of the world.

China at last acceded to the World Trade Organization (WTO) in late 2001 after 15 years of difficult negotiations. Zhu saw membership of the WTO as the guarantee of an unalterable international orientation for a China that in the past had too frequently been given to cycles of isolationism. He believed that the WTO would provide the transformational engine for economic and, to a certain extent, political modernization regardless of who controlled the government. His enthusiasm for engagement with the world paid off as trade with China turned white hot in the years that followed (see Figure 1.2).

FIGURE 1.2 Trends in imports, exports and total trade, 1999–2007


Source: China Statistical Yearbook 2008

It was not just trade; foreign direct investment also poured in, jumping to unheard-of levels of US$60 billion a year and peaking at over US$92 billion in 2008 as the world’s corporations committed their manufacturing operations to the Chinese market (see Figure 1.3). Chairmen in boardrooms everywhere believed with Zhu Rongji that China was on a path of economic liberalization that was irreversible.

FIGURE 1.3 Committed foreign direct investment, 1979–2008


Source: China Statistical Yearbook 2009

The commitment of these foreign businessmen was not simply a function of belief. In the early years of the twenty-first century, China’s market opened up as it never had before. At the start of economic liberalization in the 1980s, foreign investors had been forced to contend with the practical consequences of the famous “Bird Cage” theory. Trapped in designated economic zones along the eastern seaboard, just as they had been in the Treaty Ports of the Qing Dynasty a hundred years earlier, foreign companies were forced into inefficient joint ventures with unwanted Chinese partners. Then every local government wanted its own zone and its own foreign birds, so that during the 1990s, economic zones proliferated across the country and were eventually no longer “special.” Despite this, even as late as 2000, the joint-venture format accounted for over 50 percent of all foreign-invested corporate structures. After China’s accession to the WTO, this changed rapidly. It seemed that China was open for business after all: by 2008, nearly 80 percent of all foreign investment assumed a wholly-owned enterprise structure (see Table 1.1). At long last, the Treaty Port system seemed a thing of the past, as foreign companies had the choice of where and how to invest.

TABLE 1.1 FDI by investment-vehicle structure, 2000–2008

Source: US-China Business Council; as a percent of total utilized FDI


Over the past few years, they have undeniably committed their technologies and management techniques and learned how to work with China’s talented workers to build a world-beating job-creation and export machine. But they have done this in only two areas of China: Guangdong and the Yangzi River Delta comprising Shanghai and southern Jiangsu Province (see Figure 1.4). The economies of these two regions are dominated by foreign-invested and private (waizi image and minying image) companies; there is virtually no state sector remaining. These areas consistently attract 70 percent of total foreign direct investment and contribute over 70 percent of China’s exports. They are the machine that has created the huge foreign-exchange reserves for Beijing and they have changed the face of these two regions. It is highly ironic that the old Treaty Ports, which once symbolized its weakness and subservience to foreign colonizers, are now the source of China’s rise as a global manufacturing and trading power, becoming in the process the most vibrant and exciting parts of the country and, indeed, of all Asia.

FIGURE 1.4 US$818 billion accumulated FDI by province, 1993–2008


Source: China Statistical Yearbook, various

China’s economic geography is not simply based on geography. There is a parallel economy that is geographic as well as politically strategic. This is commonly referred to as the economy “inside the system” (tizhinei image) and, from the Communist Party’s viewpoint, it is the real political economy. All of the state’s financial, material and human resources, including the policies that have opened the country to foreign investment, have been and continue to be directed at the “system.” Improving and strengthening it has been the goal of every reform effort undertaken by the Party since 1978. It must be remembered that the efforts of Zhu Rongji, perhaps China’s greatest reformer, were aimed at strengthening the economy “inside the system,” not changing it. In this sense, he is China’s Mikhail Gorbachev; he believed in the system’s capacity for change as well as the dire need for its reform. Nothing Zhu undertook was ever intended to weaken the state or the Party.

Understood in this context, the foreign and non-state sectors will be supported only as long as they are critical as a source of jobs (and hence, the all-important household savings), technology and foreign exchange. The resemblance of today’s commercial sector in China, both foreign and local, to that of merchants in traditional, Confucian China is marked: it is there to be used tactically by the Party and is not allowed to play a dominant role.


Foreign investment has enriched certain localities and their populace beyond recognition, but foreign financial services have done far more on behalf of the Party and its system. It is not an exaggeration to say that Goldman Sachs and Morgan Stanley made China’s state-owned corporate sector what it is today. Without their financial know-how, SOEs would long since have lapsed into obscurity, out-competed by China’s entrepreneurs, as they were in the 1980s. In the 1980s, who could have named a single Chinese company other than Beijing Jeep, a joint venture, and, maybe, Tsingtao Beer, a brand from the colonial past? In Shenzhen, there is a huge billboard with a portrait of Deng Xiaoping located on the spot where he made his famous comments during his historic “Southern Excursion” of January 1992. If Deng had not said that capitalist tools would work in socialist hands, who knows where China would be today? His words provided the political cover for all others who, like Zhu Rongji, wanted China’s “system” to move forward into the world.

In early 1993, Zhu took the first big step forward when he accepted the suggestion of the chief executive of the Hong Kong Stock Exchange to open the door for selected SOEs to list on overseas stock markets. He knew and supported the idea that Chinese SOEs would have to undergo restructuring in line with international legal, accounting and financial requirements to achieve their listings. He hoped that foreign regulatory oversight would have a positive effect on their management performance. His expectations in many ways were met. After several years of experimentation, companies began to emerge with true economies of scale for the first time in China’s 5,000-year history.

Where did such Fortune Global 500 heavy-hitters as Sinopec, PetroChina, China Mobile and Industrial and Commercial Bank of China come from? The answer is simple: American investment bankers created China Mobile out of a poorly managed assortment of provincial post and telecom entities and sold the package to international fund managers as a national telecommunications giant. In October 1997, as the Asian Financial Crisis was gathering momentum, China Mobile completed a dual listing on the New York and Hong Kong stock exchanges, raising US$4.2 billion. There was no looking back as China’s oil companies, banks and insurance companies sold billions of US dollars of shares in initial public offerings (IPOs) that went off like strings of firecrackers in the global capital markets. All of these companies were imagined up, created and listed by American investment bankers.

To symbolize this transformation, the government planned a new target. After China Mobile’s successful IPO, Beijing sought as a matter of policy to place as many Chinese companies on the Fortune Global 500 list as possible. With the willing help of international investment banks, lawyers, and accounting firms, China has more than achieved this goal. The country is now proudly represented by 44 companies on the list (see Table 1.2). Among these companies are five banks, including ICBC, which ranked eighty-seventh by total revenues (as compared to twenty-fifth for JPMorgan Chase). Sinopec and the huge State Grid Corporation ranked seventh and eighth, respectively. The “National Team” was born.

TABLE 1.2 Chinese companies in the Fortune Global 500, FY2009

Source: Fortune, July 26, 2010



Revenues (US$ million)





State Grid



China National Petroleum



China Mobile Communications



Industrial & Commercial Bank of China



China Construction Bank



China Life Insurance



China Railway Construction



China Railway Group



Agricultural Bank of China



Bank of China



China Southern Power Grid



Dongfeng Motors



China State Construction Engineering



Sinochem Group



China Telecommunications



Shanghai Automotive



China Communications Construction



Noble Group



China National Offshore Oil






China FAW Group



China South Industries Group



Baosteel Group






China Huaneng Group



Hebei Iron & Steel Group



China Metallurgical Group



Aviation Industry Corporation of China



China Minmetals



China North Industries Group






Shenhua Group



China United Network Communications



People’s Insurance Company of China



Ping An Insurance



China Resources



Huawei Technologies



China Datang Group



Jiangsu Shagang Group



Wuhan Iron & Steel



Aluminum Corporation of China



Bank of Communications



China Guodian


At the start of the 1990s, all Chinese companies had been unformed state-owned enterprises; by the end of the decade, hundreds were listed companies on the Hong Kong, New York, London and Shanghai stock exchanges. In those few short years, bankers, lawyers and accountants had restructured those of the old SOEs that could be restructured into something resembling modern corporations, then sold and listed their shares. In short, China’s Fortune Global 500 companies were the products of Wall Street; even China’s own locally listed version of investment banking, represented by CITIC Securities with a market capitalization of US$26 billion, was built after the American investment-banking model.

China’s capital markets, including Hong Kong, are now home to the largest IPOs and are the envy of investment bankers and issuers the world over. With a total market capitalization of RMB24.5 trillion (US$3.6 trillion) and more than 1,800 listed companies, the Shanghai and Shenzhen exchanges have, in the last 10 years, come to rival all exchanges in Asia, including the Tokyo Exchange (see Figure 1.5). If the Hong Kong Stock Exchange is considered Chinese—and it should be, since Chinese companies constitute 48.1 percent2 of its market capitalization—then China over the past 15 years has given rise to the second-largest equity-capital market in the world after New York. From 1993, when IPOs began, to early 2010, Chinese SOEs have raised US$389 billion on domestic exchanges and a further US$262 billion on international markets, adding a total of US$651 billion in capital to the US$818 billion contributed by foreign direct investment. Considering that China’s GDP in 1985 was US$306 billion, only US$971 billion in 1999 and US$4.9 trillion in 2009, this was big money.

FIGURE 1.5 Comparative market capitalizations, China, the rest of Asia, and the US


Source: Bloomberg, March 26, 2010

While money is money, there is a difference in the impact these two sources of capital have had on China. FDI created an entirely new economy; the non-state sector. Over the years, the management and production skills, as well as the technologies of foreign-invested companies have been transferred to Chinese entrepreneurs and have given rise to new domestic industries. In contrast, the larger part of the US$651 billion raised on international and domestic capital markets has gone to creating and strengthening companies “inside the system.” Beijing had, from the very start in 1993, restricted the privilege of listing shares to state-owned enterprises in the name of SOE reform. The market capitalization in Hong Kong, Shanghai and elsewhere belongs to companies controlled outright by China’s Communist Party; only minority stakes have been sold.

All of these—SOE and bank reform, stock markets, international IPOs and, most of all, accession to the WTO—might be described as the core initiatives of the Jiang Zemin/Zhu Rongji program for the transformation of that part of China’s economy “inside the system.” From 2003 and the accession of the new Party leadership under Hu Jintao and Wen Jiabao, this program began to drift and even came under attack for having created “intolerable” income disparities. The drift ended in 2005 when forward progress on financial reform largely came to a halt long before the collapse of Lehman Brothers in September 2008 killed it stone dead.3


The year 2005 is fundamental to understanding China’s financial markets today—it marks the last great thrust of the Jiang/Zhu era. What remains in place continues to be very visible, providing China with the sheen of modern markets and successful reform. The stock, commodity and bond markets help support Beijing’s claim to be a “market economy” under the terms of the WTO. But the failure to complete the reforms begun in 1998 has left China’s financial institutions, especially its banks, in a vulnerable position. As the Fourth Generation Leadership took over in early 2003, there were two major initiatives underway. The first was the bank-restructuring program that had begun in 1998 and was just starting on a second round of disposals of problem loans. The second was the ongoing effort to restore a collapsed stock market to health. Zhou Xiaochuan, who had moved from being chairman of the CSRC to governor of the central bank in 2002, was Zhu Rongji’s principal architect.

Zhou had necessarily started with the banks since their fragile state in 1998 was a threat to the entire economy. Given China’s underdeveloped capital markets, nearly all financial risk was then concentrated in the banks. To create a mechanism to alleviate this stress, Zhou sought to develop a bond market. Such a market would allow corporations to establish direct financial links with end-investors and would also mean greater financial flexibility at times when stock markets were weak or unattractive. At this point in 2003, corporate debt constituted less than 3.5 percent of total issuance in China’s bond market (see Figure 1.6).

FIGURE 1.6 Bond market issuance by issuer type, 1992–2009


Source: PBOC Financial Stability Report, various

The market itself provided less than 30 percent of all capital raised, including loans, bonds and equity (see Figure 1.7).

FIGURE 1.7 Corporate capital raised in Chinese markets, 1993–1H 2009


Source: PBOC Financial Stability Report, various

Note: Interbank bonds include CGBs, financial bonds and all corporate bonds.

Over the course of 2003 and 2004, Zhou laid the ground work for his future policy initiatives. First, he actively shaped what became the first official government statement in support of China’s capital markets since Deng’s 1992 comments. In what became known as “The Nine Articles,” in early 2004, the Party emphatically affirmed the critical role of capital markets, which were defined to include the bond markets as well as the stock markets.

With this political cover in place, Zhou created the institutional infrastructure he would need to support bank reform. In September 2003, a new Financial Markets Department in the PBOC was established to lead the development of new policies and products for the bond markets. More strategically, on December 6, 2003, the PBOC established a wholly-owned corporate entity known as Central SAFE Investments (more commonly known as “Huijin”), and China Jianyin Investments, a wholly-owned subsidiary of Huijin. These entities became the crucial parts of the effort to restructure and recapitalize the Big 4 banks, channeling new capital to CCB and BOC in 2004. They also became the most fought-over piece of turf in the entire financial system.

Although Zhou’s starting point appeared to be banks and the underdeveloped bond markets, his real objective was the stock market. He knew well that bond risk continued to be borne largely by the banks and that only the stock markets truly enabled corporations to raise money directly from third-party investors outside of the banking system. To drive at a revival of the stock markets, however, was outside the scope of his jurisdiction; he would be stepping on other people’s toes. With the strong support of Jiang Zemin, who retained a place as chairman of the key China Military Commission until late 2004, as well as the help of the vice-premier in charge of finance, Huang Ju, Zhou began stepping on toes. Huang was another Shanghai holdover from the previous administration.

From early in 2005, the PBOC, working “closely” with other agencies (see Table 1.3), began implementing its plans for the bond markets, introducing a series of new initiatives one after the other. In February, rules came out permitting international institutions such as the Asian Development Bank to issue RMB bonds (“Panda Bonds”) and banks to establish mutual-fund companies as a first step toward a universal bank model. In March came regulations allowing asset-backed securities, and in May forward bond trading and a new corporate-debt product, commercial paper (CP), were introduced.

TABLE 1.3 Responsibilities for cross-regulatory financial reform

Reform Initiative

Principal Responsible Entities

Panda Bonds


Bank business model: mutual funds subsidiaries


Asset-backed securities


Forward bond trading


Commercial paper (CP)


Bank recapitalization


Failed securities company rescues


Exchange and interest-rate policy

PBOC/SAFE, MOF, Finance Small Group

Functional bond markets without interest rates set by market forces cannot exist and these are to a significant extent related to foreign-exchange policy. Here, too, Zhou was successful. In June 2005, the PBOC was allowed to de-link the RMB from its fixed exchange rate to the US dollar and over the course of the next 18 months, the currency appreciated nearly 20 percent. In addition, in 2007, interest rates were increased in a single step by two percent in what was perceived as an initial step toward market-based rates. Taken together, the conditions for an active debt market were put in place. As a package, all these moves represented the most significant effort yet to stimulate the development of a bond market, but they paled in significance with what took place in the banking sector.

In 2004, both CCB and BOC had been recapitalized. Before receiving US$45 billion in new capital from the foreign-exchange reserves, the banks had written off their remaining bad loans. There followed the sale of stakes in both banks to international strategic investors. These investors played two roles. First, their investment confirmed to the international-investor community that the banks had been successfully restructured and now represented an attractive investment opportunity. Secondly, and equally important, these strategic investors were meant to partner with the two banks and upgrade all aspects of corporate governance, risk management and product development. In short, the objective of bank reform was to strengthen banks financially as well as institutionally so that Chinese bankers could offer sound judgment and advice. Instead of their saying “Yes!” and lending floods of money at the Party’s behest, Zhu Rongji hoped to create professional institutions that could help the government avoid the mistakes of the past.

In June 2005, Bank of America (BOA) acquired the right to purchase up to a 19.9 percent interest in China Construction Bank and in July, Temasek, one of Singapore’s sovereign-wealth funds, a further five percent. As a first step, BOA and Temasek respectively paid US$2.5 billion and US$1.5 billion for nine percent and 5.1 percent interests in CCB. This set off in the Chinese media an ugly bout of political mudslinging at the purported “sell-out” of valuable state banks to foreigners. The accusations derived from the viewpoint that China’s banks were now “clean,” since all bad loans had reportedly been stripped out. So, the argument went, if foreign investors were to be brought in, they should pay a high price to compensate the state for its losses. Aside from price considerations, even the notion of introducing foreigners itself led to accusations that the nation’s financial security was being threatened. This attack from the nationalist left came to encompass the entire bank-reform process. Despite such attacks, the PBOC was able to complete both the CCB and BOC restructurings and public IPOs as planned. But from 2005, the political environment changed and with it the character of the bank-reform initiative.

At the same time the PBOC, again acting through Huijin, had begun buying up bankrupt securities companies in the name of financial stability.4 In the past, the central bank had provided what it called “coffin money” to compensate retail depositors in collapsed financial-sector entities. This time, however, its approach was different: it bought controlling equity interests in the failed securities companies. Over the course of the summer and fall of 2005, Huijin and its subsidiary, China Jianyin, acquired equity stakes in 17 securities companies—from the huge Galaxy Securities and Guotai Junan securities to smaller entities such as Minzu and Xiangcai. The PBOC’s expressed intention was to use a “market-based” approach. This meant that after restoring them to health, the bank hoped to recover its money by selling them off to new investors, and new investors would include foreign banks. From late 2004, the PBOC had put a 51 percent stake in a medium-size, bankrupt securities company up for bid among interested foreign banks. One bank had won the bidding process and a full proposal had been sent to the State Council for approval in the early summer. Zhou’s intention was to throw the entire domestic stock market open to direct foreign participation for the first time.

China has been said to have created and perhaps perfected over the millennia the art of bureaucracy. The PBOC and Zhou Xiaochuan, in the course of 2004 and 2005, seemed to have violated every norm of traditional bureaucratic behavior. The bank reforms wiped out Ministry of Finance (MOF) investments in CCB and BOC, and the corporate-debt space of the National Development and Reform Commission (NDRC) was invaded by allowing securities firms and SOEs to issue short-term debt securities. They were trying to blast open the CSRC’s territory by selling majority control of a securities company to a foreign bank. In the press, it was beginning to be said of Huijin that it was the “Financial State-owned Assets Supervision and Administration Commission (SASAC).” Even worse, the PBOC was making the case for establishing a Super Regulator that would integrate oversight of the bank, equity, and debt-capital markets under one roof. Suddenly, ugly personal attacks, which clearly emanated out of Beijing, were being made on Zhou Xiaochuan in the Hong Kong press.

A ministry-level entity such as the PBOC can only succeed against a concerted attack from many of its peers in the State Council if it has the full support of the country’s top leadership. Jiang Zemin had retired early in the year, and it was unfortunate that in the late summer of 2005, Vice Premier Huang Ju was diagnosed with terminal cancer; a key ally was lost. It was almost inevitable, therefore, that during the October National Day holidays of 2005, the State Council began to cut Zhou Xiaochuan’s initiatives down to size, restoring balance across the bureaucracies. After the holiday period, it rapidly became clear that the MOF had recovered influence over the banks, that the CSRC had succeeded in stopping majority-controlled foreign entry into its market, and that the NDRC’s authority had been enhanced. Even the heavily pro-PBOC Caijing image magazine gave the head of the NDRC a front-page cover story. The results reverberate to this day: an integrated approach to financial reform had ended. What followed has been piecemeal and limited to within the silos of authority belonging to each separate regulator.

From 1998, Zhu Rongji and Zhou Xiaochuan had built up a certain framework to pursue comprehensive reform of the financial markets. This included the creation of bad banks, the strengthening of good banks, a national social-security fund, bond markets with a broader investor base and, last but not least, stock markets open to meaningful foreign participation. In addition, there was a start to currency reform as the RMB was unlocked from its link to the US dollar. After the PBOC’s defeat in 2005, this institutional framework remained incomplete. Worse still, it has been, and continues to be, used to solve problems it was never meant to address. The reason for this is relatively straight forward: with the RMB exchange rate from early 2008 again locked in to the US dollar, interest rates and markets have been frozen in place.5 The dollars poured in (see Figure 1.8), creating massive amounts of new RMB and huge pressures within the system. Lacking an integrated set of policies, the government addressed these pressures with a plethora of ad hoc institutional, administrative and other adjustments reached by consensus decision making and compromise. The result by 2010 is a jerry-built financial structure caught somewhere between its Soviet past and its presumably, but not assuredly, capitalist future.

FIGURE 1.8 China’s foreign-exchange reserves


Source: China Statistical Yearbook 2008


What is remarkable about the financial reforms pursued by Zhu Rongji was that they were comprehensive, transformational, and pursued consistently. Failure to follow through may have been inevitable, however, given the fragmented structure of the country’s political system in which special-interest groups co-exist within a dominant political entity, the Communist Party of China. What moves this structure is not a market economy and its laws of supply and demand, but a carefully balanced social mechanism built around the particular interests of the revolutionary families who constitute the political elite. China is a family-run business. When ruling groups change, there will be an inevitable change in the balance of interests; but these families have one shared interest above all others: the stability of the system. Social stability allows their pursuit of special interests. This is what is meant by calls for a “Harmonious Society”.

In 1998, in the wake of the Asian Financial Crisis and the collapse of Guangdong International Trust & Investment Corporation (GITIC), the families united in crisis. They agreed that financial weakness threatened their system and they supported a thorough bank restructuring inspired by international experience. Now, years later, the appearance of success has been highlighted by the global financial crisis from which their banks and economy were largely insulated. It has made the families supremely confident in their own achievements. How could there be a problem with more than US$2 trillion in reserves and banks at the top of the Fortune 500? Besides, the reforms of the Jiang/Zhu era produced a group of fabulously wealthy National Champions around which many of the families cluster. Family business in China had become Big Business. The US$120 billion and more that was spent on the Beijing Olympics, the Shanghai World Expo and the Guangzhou Asian Games seemed almost immaterial; the hundreds of millions for the Sixtieth Anniversary Parade was nothing. Each of these events was bigger, better, and more expensive than anything any other country has ever managed, but each is little different from individuals being seen driving a Benz 600 or carrying the latest Louis Vuitton bag: they give the appearance of fabulous wealth and, therefore, success; they became a self-fulfilling prophecy. Given the apparent strength of the financial system, where is the need for further reform?

Failing to grasp the impact of unbridled Western-style capitalism on its elite families in a society and culture lacking in legal or ethical counterbalances is to miss the reality of today’s China. Greed is the driving force behind the protectionist walls of the “state-owned” economy “inside the system” and money is the language. A clear view over this wall is obscured by a political ideology that disguises the privatization of state assets behind continuing “state” ownership. The oligopolies dominating the domestic landscape are called “National Champions” and the “pillars” of China’s “socialist market” economy, but they are controlled by these same families. As the head of an SOE once wisely commented, “It doesn’t matter who owns the money, it only matters who gets to use it.” In China, everyone wants to use the money and few are willing to be accountable for how it is used.

The Chinese commonly joke that China is now passing through the “primitive stage of capital accumulation” described by Karl Marx. The occasional lurid “corruption” scandal provides a critical insight into what is, in fact, the mainstream privatization process: the struggle between competing factions for incremental economic and political advantage. The state-owned economy, nominally “owned by the whole people”, is being carved up by China’s rulers, their families, relations and retainers, who are all in business for themselves and only themselves. From the very start of political relaxation in 1978, economic forces were set in motion that have led to the creation of two distinct economies in China—the domestic-oriented state-owned economy and the export-oriented private economy. The first, which many confuse with China, is the state-owned economy operating “inside the system.” Sponsored and supported by the full patronage of the state, this economy was, and has always been, the beneficiary of all the largesse that the political elite can provide. It is the foundation of China’s post-1979 political structure and the wall behind which the Party seeks to protect itself and sustain its rule.

Over the past 30 years China’s state sector has assumed the guise of Western corporations, listed companies on foreign stock exchanges and made use of such related professions as accountants, lawyers, and investment bankers. This camouflages its true nature: that of a patronage system centered on the Party’s nomenklatura. The huge state corporations have adopted the financial techniques of their international competitors and raised billions of dollars in capital, growing to an economic scale never seen before in all of Chinese history. But these companies are not autonomous corporations; they can hardly be said to be corporations at all. Their senior management and, indeed, the fate of the corporation itself, are completely dependent on their political patrons. China’s state-owned economy is a family business and the loyalties of these families are conflicted, stretched tight between the need to preserve political power and the urge to do business. To date, the former has always won out.

Of course the “National Champions” dispose of great wealth and, consequently, interest groups within the Party have formed around what one official once called “these cash machines.” But misjudgment forms the character of all human beings; a simple misstep can bring down a powerful wealth machine and the families behind it. The issue then becomes how to remove the political targets while preserving the machine. The “Party”—that is, the winning interest group—can intervene for any convenient reason, changing CEOs, investing in new projects or ordering mergers. Due to these characteristics, the adoption of laws, accounting standards, markets, and other mechanisms of international capitalism are just examples of the formalism that characterizes China today. The names are the same as in the West, but what things are and how they work is hidden beneath the surface. Given the state’s scale in critical sectors, together with the enormous power of the government, the influence of this patronage system pervades all aspects of China’s economy. It inevitably undermines the very contents of its superficially internationalized institutions.

The 30 years encompassed by the policy of reform and opening have been the most peaceful and economically successful in the past 170 years of China’s history, lifting more than 300 million people out of poverty. This achievement must be acknowledged. But the character of China’s style of capitalism is marked deeply by how the political elite has coalesced around certain institutions, corporations and economic sectors, how the government and various interest groups have used Western financial knowledge, and the crises the state has met along the way. After all, every country and all economic and political systems experience booms and busts, scandals and wild speculative sprees. The difference lies in how each country manages the aftermath. The aim of this book is to pull back the edge of the Chinese curtain and peer at what is behind, to match the reality of the system’s operations with the familiarity of the names it uses to describe them and then to look into the future in the belief that a straight forward look will benefit all.


1 See Xing 2007: 739.

2 This figure could be much higher since the market capitalizations of H-share companies listed on the HKSE value only the H-shares, excluding all other shares.

3 See Wu 2009.

4 For greater detail, see Walter and Howie 2006: Chapter 9.

5 The PBOC’s statement in June 2010 that the yuan is free to float against a basket of currencies remains just that, a statement, and is unlikely to lead to significant change in the currency’s value.



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