Modern history


The Forbidden City

A huge vermillion compound filled with immense golden-roofed palaces, moats, hidden gardens and carved dragons, the Forbidden City is the heart of China’s capital. It is a masterpiece that belongs to both China and the world, for surely by now half the world must have walked through its spaces. Perhaps the significance of its structural layout exceeds even the riches left by the Yuan, Ming and Qing Dynasties and goes to the heart of Chinese organizational culture.

Entering the palace through the Meridian Gate, one is struck with the great spaces enveloped by looming outer walls. Once through these massive walls, the visitor walks across marble bridges spanning the Golden Waters toward the Gate of Supreme Harmony. This is another, even broader, space, overwhelming in its grandeur, its walls receding into the distance. The courtyard’s overall design is awe-inspiring; it seems to encompass both heaven and earth. As one penetrates more deeply into the palace, however, spaces become smaller, and long, narrow corridors are punctuated here and there by small entrances. The huge walls close in, progressively blocking off all lines of sight.

Even before finally entering the Imperial Garden, with its constricted space, rock gardens and towering Hall of Imperial Peace, the visitor comes to the realization that, like the gardens and the trees, he too is boxed in by the design. The great spaces at the Palace entrance are mere illusions because, in truth, there is just one way to look beyond the walls and that is to look up. Only the Emperor in his palaces atop the walls could see into the courtyards both large and small; those below were constrained to act within their allotted space. Cut off by walls from other courtyards and, indeed, the rest of the Palace, within their own space people were free to pursue the activities assigned to them. Only the Emperor had the authority to intervene and only he could understand the larger design of their work.

The workings of the Forbidden City in Imperial times serve as a metaphor for China’s government and political practice today. At the center lies Beijing, a complex labyrinth of separate power centers, each with just a single reporting line that extends up to the party secretary general (although nominally through the State Council, the premier and the National People’s Congress). Coordination or integrated action across multiple bureaucracies is difficult and time-consuming unless it is ordered by the party secretary general. Without a strong leader, each bureaucracy proceeds within its own scope of authority and jealously guards the entrance to its courtyard. The only way to join the “emperor” in his palaces a top the walls is either through lineage, or by maximizing achievements within one’s own narrow grounds, or both. Then, of course, there may be some who prefer to stay within their own courtyards, pursuing their own interests.

As the China Development Bank’s attempt to replace the Ministry of Finance in the bond markets and the tug-of-war between the MOF and the People’s Bank of China over control of the major banks have shown, there is a great deal of predatory behavior exhibited within the walls of this monumental edifice. There is also much copycat behavior. The China Securities Regulatory Commission (CSRC) has its securities companies and stock markets in one courtyard; in another, the China Banking Regulatory Commission (CBRC) has its own investment-banking platform, the trust companies, and access to the debt markets. And how else to explain the SASAC’s belated press release that it has created its own domestic sovereign-wealth fund in replication of China Investment Corporation; or to explain Huijin, which itself replicates SAFE Investments? It would be easy, of course, to go beyond these relatively specialized entities to include the large SOEs. When PetroChina acquires companies overseas on behalf of the government, isn’t it also a sovereign-wealth fund? All this demands the simple question: What in China isn’t a sovereign-wealth fund?

Only a strong premier or party secretary can coordinate such activity to ensure it is in line with the Party’s general goals; only they can channel the energies of government and Party leaders and minimize costs. The absence of a strong leader is a weakness that allows the special-interest groups to take advantage. A vice-premier in charge of finance may understand his remit, but unless he has the ear of the general secretary, it is to no avail. A central bank governor may know clearly the critical issues across the financial maze, but unless he is supported, political compromise will trump all else. On the other hand, for the National Team, the less scrutiny there is, the better.


This perspective suggests just how great an achievement the securities markets, no matter how flawed, really are. From 1992, for the first time in its long history, China had a national market and it was a market for capital, and that capital could flow without hindrance across all government jurisdictions. Not only that, at the start these markets had a single “emperor” overseeing them, the People’s Bank of China. The PBOC (or, more accurately, its powerful provincial branches, together with the local Party) was the great force behind market development during the late 1980s. Liu Hongru, a PBOC vice-governor at the time, is commonly recognized by all participants as the “godfather” of the stock markets. The central bank oversaw the establishment of China’s first 34 securities companies in 1988. From 1985, its Shenzhen branch played a critical role in developing market infrastructure and regulations, while the PBOC head office played the key coordination role among government-market stakeholders. Without the PBOC’s initiative and support, China’s experiment with shares and stock markets would have been stillborn. Moreover, the PBOC’s sponsorship opened the international markets to Chinese IPOs, as was resoundingly demonstrated in October 1992 with the first-ever listing of a Chinese SOE on the New York Stock Exchange. This sort of daring would never have been possible with consensus leadership.

Over the course of the 1990s a fragmented regulatory environment began to take shape, particularly after 1997 when Zhu Rongji moved the government-bond market from the securities exchanges and the CSRC’s oversight to the inter-bank market under the supervision of the PBOC. This was just the beginning. By 2003, seven regulators were responsible for the four major categories of bond products, and equity and commodities had also been parceled out. Each regulator had its favored group of financial institutions or markets—the PBOC had the debt markets; the CSRC and the NDRC had the securities companies and commodities brokers; the MOF had the banks; the CBRC had the trust companies; and the CIRC had insurance companies and private-equity funds. Now even the NDRC is looking for that special vehicle that can give it access to the financial markets. The capital markets are thus divided up into small areas of special interest and members of that group are thereby guaranteed a slice of the action with the help of their own patrons (see Figure 8.1).

FIGURE 8.1 Capital-market products by regulator and business beneficiary, FY2009


Source: Wind Information

This is not to say that a single Super Regulator is necessarily the answer to coordination across China’s capital markets. There are good reasons for different regulators for different sectors; stock broking is not banking, and vice versa. The trouble is that in China, the different regulators have over the past few years created so-called “independent kingdoms”; effective coordination across these fiefdoms has been difficult in the apparent absence of strong political leadership.

The lack of a unitary market regulator may have been less important in the 1990s when banks were almost the sole source of capital in the economy. But after the Asian Financial Crisis, Zhu Rongji’s plans to radically restructure the Big 4 banks required a far more integrated approach. Recapitalizing the banks was only one part of a larger plan designed to address the problem of systemic risk. But an integrated solution required the coordination and active support of a wide variety of government agencies including the MOF, the SPC/NDRC, the CSRC and the PBOC. Who would lead? Zhu Rongji was both willing and able to drive financial reform forward until the end of his term in 2003; the momentum that had built up from 1998 carried through until 2005. But, in his absence, when the PBOC sought to institutionalize these reforms in 2005, with itself as the Super Financial Regulator, supporters of the status quo, led by the MOF, pushed back hard enough to stop the consolidation of an integrated approach to financial markets.

As outlined in earlier chapters, when the MOF took back control of the banks from the PBOC, China’s financial system incurred a high cost for its bureaucratic revenge. Foreign investors made a down payment through their participation in IPOs that were, in fact, a prepayment of cash dividends used to make good the interest payments on the MOF’s Special Bond. For their part, China’s major banks became simple channels for this interest, as well as for payments on the special “receivables” the MOF used to restructure Industrial and Commercial Bank of China and Agricultural Bank of China. It would seem that with the MOF’s interest being paid by the banks, the national budget did not need to bear the expense. Perhaps this explains why this Special Bond is no longer recorded in the PBOC’s central depository; after December 31, 2007, these bonds simply disappeared. In addition, the major banks are now in search of another US$42 billion to fill an equivalent gap in their capital created by dividend payments. Even more ungainly, the new sovereign-wealth fund suddenly found itself to be the heart of the entire banking system.

These are the costs to the system when complexity reigns and there is no “Emperor of Finance”. Since 2005, there has been some talk of a unitary financial regulatory body, but there has been little of any substance to emerge except, perhaps, the idea of a “Super Coordinating Commission” that would include all stakeholders. However, just such an agency had existed before, in the late 1980s, and had proved a failure. Who would lead such a commission when even previous coordinating meetings between these regulatory agencies had lapsed into disuse because of “scheduling difficulties”?


So, without a strong champion for change, the status quo asserted itself; each of the major stakeholders in the system settled back inside its own “courtyard” and pursued their own interests including, especially, seeking access to increasing amounts of bank money. This poorly coordinated chase for funding has rapidly led to significant growth in China’s public-debt burden. The data in Table 8.1 illustrate the various stakeholders who have contributed to China’s stock of public obligations. For simplicity, the only changes in the projection for 2011 from 2009 are in the estimates of local-government obligations and non-performing loans, the two areas with potentially the greatest variability. These estimates are meant to be conservative and serve simply to show the scale of debt that has already been built up. To be clear, these numbers represent debt obligations; this does not imply that there is no value to the assets or services or other activities that such debt finances. But at a certain point, the cost of these liabilities adds up to a critical mass, becomes burdensome for an economy, and begins to inhibit economic growth. The international standard for such a red line is 60 percent of GDP, beyond which growth may suffer as a government spends more on managing its debt burden than on investing in growth-creating programs.

TABLE 8.1 China public-debt obligations, 2009 and 2011


The table shows that if only the obligations of the MOF (as representative of the sovereign) are used to define central-government debt, then China’s debt ratio is less than 20 percent of GDP, well below the international standard. This is the commonly held view, but it ignores how Beijing has structured its finances over the past decade. The MOF once funded a national budget that included major investments in infrastructure and other fixed assets. Today, such projects are outside the budget and are the responsibility of the policy banks and an aggressive Ministry of Railways (MOR). The obligations of these near-sovereign (if not fully sovereign) entities should be included as part of China’s public debt: would the Party allow any of the policy banks to fail? Such sovereign entities include the MOR, the policy banks, the subordinate debt of the major state banks, as well as any known contingent obligations incurred by the MOF itself (those IOUs plus the 1998 and 2007 Special Bonds). When these obligations are included, public debt almost doubles, to 43 percent.

To this must be added the obligations of local governments, which are without doubt a part of the China sovereign. Beijing historically has been aware of this debt and that it is substantial; a quick look at the finance section of any China Statistical Yearbookillustrates this point. The Party, however, is conflicted: Does it really want to know the exact picture? Most successful Party leaders must at some point in their careers serve in the localities. Since local budgets are severely constrained, creative funding solutions—many of which would not withstand outside scrutiny—are the only choice open to the ambitious Party leader. Consequently, the best choice is not to arouse such scrutiny. Local governments comprise more than 8,000 entities at four distinct administrative levels. What is known is that the stock of local debt increased enormously after the announcement of the stimulus package in late 2008. Beijing required local governments to contribute at least two-thirds of the publicly announced total of RMB4 trillion.

This discussion is not meant to suggest that all these figures are exact and correct; it is enough to know the approximate scale of such obligations. In early 2010, Beijing publicly admitted to a figure for total local debt of RMB7.8 trillion—23 percent of GDP and likely to increase over the next few years, if only to complete projects already under way. One estimate of such additional funding needs is RMB4 trillion. There will undoubtedly be additional credit extended but, given the creative financing possibilities offered by the interaction of governments, banks, trust companies and finance companies, no one can know how much. For the purposes of this discussion, it is simply assumed that only RMB4 trillion is spent, so that by 2012, total local debt will be close to RMB12 trillion, or 28 percent of estimated GDP. While no one knows the true amount of local-government debt in China (the banking regulator most certainly does not), if the Hainan and GITIC experiences can be used as reference points, the scale of such debt is as vast as the country it finances.

Not to be forgotten in all of this are the non-performing loans, both current and those obligations yet to be written off from the 1990s. For the upcoming crop of NPLs that will derive from the stimulus-package lending of 2009 and follow-on loans of 2010, a total of about RMB20 trillion (US$2.9 trillion) is assumed.1 Of this, 20 percent is assumed to have gone to local governments, while the other 80 percent relates to typical SOE or project lending for which new NPLs are estimated, based on a 20 percent rate that begins to be seen in 2011. For the obligations left over from the earlier bank restructuring, the total of RMB3.2 billion is a hard figure derived from audited financial statements and the bank regulator. Together, these old and forecast NPL numbers yield a total of RMB6.4 trillion or over 15 percent of estimated GDP for 2011.

Adding all this up suggests that as of year-end 2009, China’s stock of public debt stood at nearly 76 percent of GDP, well above the international standard. This burden can only increase, given China’s practice of generating a significant portion of GDP growth through fixed-asset investment. Others will arrive at different estimates. The point is simply that in the past few years, China has quickly built up significant levels of public debt, and that is without taking the value of contingent liabilities, such as social security obligations, into consideration.


What if this debt buildup is not just the result of a weak hand at the financial tiller? It may also be accurate to say that these increases are the result of the government deliberately leveraging China’s domestic balance sheet to achieve its policy goal of high GDP growth. The economics are simple and well understood: borrow expensive RMB now to build projects the state believes it needs, and make repayment at some point in the distant future using inevitably cheaper RMB.

Figure 8.2 shows the growth of outstanding central-government debt, here defined narrowly as that of the MOF plus the three policy banks and the Ministry of Railways only, as against the public debt of four developed economies, including the US. These developed economies have issued debt for a century; at times, as in the case of England in the late 1940s, national debt has been more than 200 percent of GDP. At times, these governments have even defaulted on their debt, as Germany did after World War II. These developed economies have extensive experience in managing public debt, both positive and negative. What is interesting about this chart is how in just a few years, China’s narrowly defined stock of debt seems to be catching up with the levels of developed countries, some with a GDP many times larger than China’s.

FIGURE 8.2 Trends in outstanding public debt: US, Europe and China, 1990–2009


Source: China Bond and International Monetary Fund

Note: China’s public debt includes only the MOF, the three policy banks, and the MOR. The Special MOF bonds of 1998 and 2007 are included.

This picture of government borrowing is also illustrated by the amount of the annual national budget financed by new debt net of that issued to repay maturing bonds (see Table 8.2). Such debt issuance represents new money and finances new budgetary spending and, of course, it will add to the stock of a country’s obligations. In 2009, for example, net new bond issues from the MOF and the policy banks supported 22 percent of national expenditures, while new CGB issues alone financed 57 percent of central-government expenditures.2 Similar to other Asian countries, China’s national budgets seem to be dependent on increasing amounts of debt.

TABLE 8.2 Net new-debt issuance as proportion of government expenditure, 1997–2009

Source: China Statistical Yearbook, China Bond; author’s calculation

Note: 2007 might be considered an anomaly given MOF’s RMB1.55 trillion Special Bond.


The budgetary dependence on debt can also be seen in the rapidly increasing amount of maturing central- and policy-bank debt. Over the period 2003–2009, the value of maturing MOF and policy-bank bonds grew at an annual compounded rate of 26.5 percent. These bonds were all refinanced; that is, rolled over into the future (see Figure 8.3). Net new debt plus debt issued to repay (and roll over) maturing debt equals the total amount of debt issued by China each year. Both add to the stock of China’s outstanding public debt.

FIGURE 8.3 Amount of MOF plus policy-bank debt rolled over, 1997–2009


Source: China Bond

Note: Retired debt is calculated as a function of year-end depository balances and annual new debt issuance.

It might be the case that this debt machine is not fully understood by China’s most senior leaders or they may be aware only of the more narrowly defined levels reported in the media. China’s public-debt figure is typically presented as only MOF obligations, its most narrow definition. It is unlikely to be a coincidence that of the total of China’s domestic debt obligations, only one percent is held directly by the end-investor: savings bonds. Aside from a minimal amount held by foreign banks and QFII funds, all else is either held or managed by state-controlled entities, from banks to fund-management companies. As the CEO of ICBC explained, China relies on “indirect” financing to achieve its economic growth goals. This means that banks decide on behalf of depositors how, to whom and under what conditions to lend deposits out. In a capital-market model, there is less room for such an intermediary; the end-investor is independent of the debt or equity issuer and makes investment or divestment decisions based on considerations independent of the interests of the issuer or borrower. In China, this is not the case: the Party controls the banks and the banks lend, as directed, to state-owned entities.

This is precisely where China differs from Mexico of 1994, Argentina of 1999 and Greece and Spain today. Aside from trade finance, China does not borrow money overseas and, because of the non-convertibility of the RMB, offshore investors are overwhelmingly excluded from the domestic capital markets. Nor are foreign banks competitive in the domestic loan and bond markets, given their need to make an adequate return on capital. As a result, foreign banks rarely contribute more than two percent to total financial assets in China; after the lending binge of 2009, they now stand at 1.7 percent. The only other major entry point into the system, QFII, is a CSRC product that is directed at the stock markets rather than bond markets. In any event, the current total quota allocated is, at US$17.1 billion, a relatively small amount. Even if fully invested in bonds, this would still pale by comparison with outstanding bond obligations of US$1.87 trillion. There is simply no way that offshore speculators, investors, hedge funds or others can get at China’s domestic debt obligations and challenge the Party’s valuation of these obligations. In short, the closed nature of China’s financial markets suggests a deliberate government strategy based on a particular understanding of past international debt crises. China’s financial system is an empire set apart from the world.


The fact that it is well-insulated from outside markets does not mean that China’s finances are crisis-proof. The system can be disrupted by purely internal factors, as it clearly has been in the past. Take, for example, household savings, pension obligations and interest-rate exposure. Household savings are the foundation of the banks’ capacity to lend. The heroic savings capacity of the Chinese people is virtually the only source of non-state money in the game. Since 2004, China’s banks have enthusiastically expanded their consumer businesses to include mortgages, credit and debit cards and auto loans. What would happen to bank funding if the Chinese people learned how to borrow and spend with the same enthusiasm as consumers in the United States? Over the long term, this might be good for the economy and even for the banks. But in the short-to-medium term, it seems unlikely that the government will actively encourage American-style consumerism outside of the rich cities of the eastern seaboard. This, in itself, may be a source of great social instability as the more numerous relatives in the hinterlands become envious of leveraged lifestyles.

The overall demographic is pushing in the same direction. By 2050, XinhuaNews has stated, one out of four Chinese will be over the age of 65, but the actual number of retirees will be far greater (see Table 8.3). As the population ages, savings will be spent on old-age and health care. If the government continues to pursue growth through borrowing, the possibility of developing an economy based more on domestic consumption than export growth would seem low.

TABLE 8.3 China’s ageing population

Source: World Bank, Wall Street Journal Asia, June 15–17, 2001: M1


This also suggests that full funding for any national social-security program is a reform whose time is unlikely to come. Despite a strong beginning in 1997, the government continues to face difficulties in creating a standardized national program, on the one hand, and, on the other, sufficiently funding the programs it does have. Moreover, the funds it has under management lack suitable investment opportunities that can, with acceptable risk, yield returns higher than the rate of inflation. As noted earlier, at present only stocks and real estate, both highly speculative in nature, can potentially provide such a return. This harks once more back to the issue of China’s stunted capital markets. As the workforce ages, it appears likely that Beijing may have to fund any gap in such obligations largely through debt issuance.3 The Ministry of Labor and Social Security has estimated this contingent liability to be only RMB2.5 trillion, whereas in 2005, the World Bank arrived at an estimate of RMB13.6 trillion. This puts the range at somewhere between 10 to 40 percent of China’s GDP; a very large obligation.

China’s debt strategy is also vulnerable to increases in interest. At some point, a heavy interest burden arising from increasing amounts of debt will limit the government’s ability to invest in new projects and grow the economy. Very rough estimates suggest that, as of FY2009, total interest expenditure on central- and local-government debt represents 12 percent of national budget revenues and may grow over the next two years to 15 percent (see Table 8.4). Inflation also poses a threat since it would both increase these government borrowing costs and put pressure on the valuation of bonds held on the banks’ books as long-term investments; valuation provisions would have to be made. This is why the PBOC finds it so difficult to raise interest rates, thus limiting the range of tools at its disposal to deal with inflation. Raising bank lending rates affect enterprise performance and have a knock-on effect in the bond markets. It also raises expectations of currency appreciation and, therefore, can encourage inflows of hot money. The PBOC last changed lending rates (downward) in late 2008 and has since relied solely on the previously little-used deposit-reserve requirement.

TABLE 8.4 Estimated interest expense of central and local debt, 2009–2011

Note: Assumes revenues grow eight percent annually; interest rates for central-government bonds reflect data in the ICBC FY2009 performance review; local-government debt interest rate assumed four percent over one-year deposit rate. Interest rates remain unchanged through 2011.


This reserve tool was first established in 1985. Used only four times prior to 2003, it has been employed 28 times since. It limits a bank’s capacity to make loans by removing a proportion of bank deposits: no funding, no loan. Currently the reserve ratio stands at 17 percent, which is close to its historic high of 17.5 percent; that is, 17 percent of all bank deposits sit in the PBOC’s accounts. Using this policy tool and making massive sales of short-term notes into the inter-bank market are all the PBOC can do to manage China’s money supply. It is little wonder that the central bank is vulnerable to political conservatives touting the efficacy of Soviet-style administrative intervention.

None of this means that China is in danger of default or even of a slowing in economic growth. If properly managed, there is no reason why China’s use of debt can’t continue for a long time. Witness the ongoing debt crisis in Europe, which has been a decade in the making. In the case of Greece, it appears likely that its financial accounts were managed to meet the requirements of entry into European Economic Community from the start. Yet it is only today, more than a decade later, that problems have emerged in public and markets have focused on them. Greece is an open economy with a thriving democracy. Think how long things may be obscured within China’s still-opaque economic and political system.

Given China’s geographical size and huge population, it is unlikely that its economy will grind to a halt in the way that Japan’s did after its magnificent run in the 1980s. Unlike the Japanese banks then, China’s banks are not deregulated nor are they near being sufficiently international to consider “going out,” even if the Party would allow them to do so. To this can be added the very big lesson China’s government appears to have learned from Japan: keep a tight lid on currency appreciation. China knows well that when Japan freed up the yen to appreciate and deregulated its financial markets, it was entering the last stage of its wild asset bubble. The Party will perhaps allow the RMB to appreciate a little to defuse diplomatic tensions, but it will never make the currency freely convertible. All of the talk around the internationalization of the RMB has proven its weight in gold diplomatically, but it cannot be any more than that unless holders of the RMB are able to use it freely offshore like any other currency. Until then, “internationalization” of the yuan is simply another form of barter trade.

In sum, China’s growing dependence on debt to drive GDP growth implies that there will be no meaningful reform of interest rates, exchange rates or material foreign involvement in the domestic financial markets for the foreseeable future. Nor will there be any further meaningful reform or internationalization of the major banks, although future recapitalizations will inevitably take place. The events of the fall of 2008 have put an additional seal on this outcome. “Don’t show me any failed models,” is the refrain of Chinese officials these days. But is its 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?


Against this background, the question has to be asked: why go to the trouble of building debt and stock markets when the banks stand behind everything? Why don’t the banks simply lend directly to the MOF or the CDB, just as they do to the local governments and their projects? What is the advantage of creating such a complex and difficult-to-manage financial system?

The answer to such questions is complicated and has many aspects. These include that the system serves as: i) an important catalyst for corporate transformation; ii), a mechanism allowing money to flow among various groups; and iii) a familiar surface for local business and politics that attracts foreign support and admiration. First of all, in the late 1980s as it considered SOE and other economic reforms, the Party wanted to make use of the most advanced economic practice available. The Western financial model, involving shareholding and capital markets, seemed to offer this. With strong support from Deng Xiaoping, a consensus formed around the active pursuit of equity-capital markets and SOE IPOs as channeled by Western legal, accounting and regulatory practices. In just a few short years, experimentation with international listings led to the creation of perhaps the largest Chinese enterprises in history: the National Team began to form.

This can only have been seen by the Party as a great success, but the National Team was also, in many ways, the gamechanger in China’s political economy. Endowed with great economic and political power, why should these huge state enterprises want a domestic (or international) regulator or any other government agency to have a significant influence over their operations? Would such corporations want China’s stock markets, including Hong Kong, to develop toward international best-practice standards? The answer at this point appears to be “No.” The National Champions have the clout to slow, if not halt, market development if it is not in their interest. This explains why China presents such a mixed picture to international observers. Its markets have all the trappings of Western finance: B-shares, H-shares, locally incorporated bank subsidiaries, local-currency derivatives, QFII, QDII, securities, mutual fund and commodities joint ventures—all have been tried, some with great success, but they remain small extensions to the vast grounds of the Forbidden City.

There has been talk of an international board on the Shanghai Exchange since at least 1996 when Mercedes Benz sought a listing in Shanghai. In the debt markets, only the Asian Development Bank and the International Finance Corporation have been allowed to issue bonds, and only within the existing interest and investor framework and to fund state-approved projects. China’s lively and important non-state sector has been allowed access to the Shenzhen stock market since 2004, but of the 400 companies listed, only four have made it to China’s Top 100 by market capitalization and altogether they account for just 2.2 percent of total capitalization. In addition, the non-state companies are to be found in such areas as consumer, food, certain areas of hi-tech, pharmaceutical and other light industrial sectors in which the Party historically has had little stake. In short, the non-state sector, no matter how important to China’s exports and employment, has not been allowed to develop into a challenge to the National Team.

The second aspect to answering this question is that it suits China’s powerful interest groups to have a complex yet primitive financial system in which money frequently changes hands. Multiple products, regulators, markets and rules all disguise the origin and destination of China’s massive cash flows. In this business environment, the National Champions, their family associates and other retainers plunder the country’s large domestic markets and amass huge profits. With nationwide monopolies or, at worst, oligopolies, these business groups do not want change, nor do they believe that foreign participation is needed. How can China use its Anti-Monopoly Law when the Party owns the monopolies? The addition of foreign participants simply makes things more complicated than a simple consideration of the possible value they might add; why share the wealth? If Zhu Rongji’s intention in signing China up to the World Trade Organization was to open it up to foreign competition and, therefore, economic change, after 2008, this goal seems to have faded from sight.

Can it be fairly said that these business interests are, in fact, China’s government? Is it simply that, lacking a strong leader, the government presently cannot set its own agenda if it is in conflict with that of the National Team? The answer may well be “Yes.” As far as the financial sector goes, the collapse of Lehman Brothers in September 2008 undermined the influence of those in the Party who sought a policy of greater openness and international engagement. The global financial crisis eliminated the political consensus in support of the Western financial model that had been in place since 1992. This has allowed the pre-reform economic vision of an egalitarian socialist planned economy to re-emerge. There are many in the Party and the government who never supported Red Capitalism in the first place. Like the old cadre quoted at the start of Chapter 1, these people have always wondered what the revolution had been for if it simply meant a return to the pre-revolution era of the 1930s and 1940s, with all its excesses. They see today the re-emergence of the same issues that led to the revolution in the first place. What they misunderstand is that without Western finance and open markets, China would not have achieved the extraordinary rise of which they are so justly proud.

There has been a great cost to China as a result of the Party’s support for the National Team but the entire intention of creating National Champions should be understood against the backdrop of the globalization of industries taking place in the late 1990s.4 In almost every industrial sector, China was beginning to face international competitors of a scale, expertise and economic clout that its own companies simply did not possess. The success of the US$4.5 billion China Mobile IPO in 1997 showed a way forward. The goal of placing companies on the Fortune 500 list for Zhu Rongji became the equivalent of America’s Apollo moon program. Ironically, however, the new National Champions were born with too much political power—the Party should never have allowed their chairmen and CEOs to remain on the nomenklatura and enjoy such great political influence. As a result, these companies grew fat, wealthy and untouchable as they developed China’s own domestic markets and always with the unquestioning support of a complaisant financial system.

Since they are so comfortable in a domestic market closed to meaningful foreign competition, the National Team faces great difficulties developing into an International Team. If China’s banks are the strongest in the world, where were they when Western commercial and investment banks were on the ropes, ready to be bought for a song? It is entirely disingenuous to say, as a major Chinese banker has said, that the developed markets do not present significant profit opportunities for China. Rather, the government appears to be far happier working in weak economies, where its mix of economics and politics is quite effective. But this still demands the question: where is China’s International Team?

There is a third aspect to China’s mixed financial scene and involves a picture that outside observers, whether political, business or academic, feel comfortable with since it makes China resemble other emerging markets. In this regard, the infrastructure is the thing. Over the past 18 years, China has developed stock and debt-capital markets, a mutual-funds industry, pension funds, sovereign-wealth funds, currency markets, foreign participation, an internationalist central bank, home loans and credit cards, a burgeoning car industry and a handful of brilliant cities. As it looks like the West, international investors easily accept what they see; they are excited by it because it is at once so familiar and so unexpected. There is the feeling that all can be understood, measured and valued. They would not feel this way if China explicitly relied on a Soviet-inspired financial system even though, in truth, this is largely what China remains.

The Chinese commonly explain the complexity of their system saying: “Our economy is different from the West, so our markets work differently than those in the West.” It turns out that this is a simple statement of the truth. China is an economy that, from the outside, appears as a huge growth story; one extraordinary boom that has continued over the last 10 years. This is just the surface. China has been a series of booms and busts within its overall growth story; it deserves and repays far closer scrutiny from all sides including the Chinese themselves, but especially from those in the West. One cannot simply assume that words such as “stocks” or “bonds” or “capital” or “yield curves” or “markets” have the same meaning in China’s economic and political context. To do so reflects a lack of curiosity and seriousness that can rapidly lead to misunderstanding and wasted opportunity. It is a luxury that neither China nor its foreign partners can afford. The prolonged efforts of the Party and government to mix Western capital markets with state planning have produced spectacular change in a short period. This has obscured the fact that all able bodies are desperately engaged in “the primitive accumulation of capital” in an unprecedented social experiment. If Karl Marx were alive today, he would without doubt find plenty of material for a new version of his masterpiece which he might call Das Kapital with Chinese characteristics.


1 This is derived as follows: 2009, RMB9.56 trillion actual; 2010, RMB10 trillion based on annualized 1Q 2010 actual lending.

2 Bond issues are accounted for as revenue in China’s budget accounting. Since 2000, interest expense has been included in expenditure budgets, but repayment of maturing bond debt is not included as an expenditure item.

3 Since 2008, the government has adopted the old 2001 policy of paying 10 percent of the shares of listing companies into the National Social Security Fund. Even so, the fund continues to be seriously underfunded.

4 See Nolan 2001 for an extensive discussion of SOE reform in the context of the global consolidation of industry.

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