Tuesday, March 29, 2011

'Red Capitalism' Review: Evaluating China's Financial Foundation and Extraordinary Rise

Article Seeking Alpha

The Chinese economic growth in the last decade has been the envy of the world. There has not been a serious challenge to the economic power of the United States since the 1980’s, when Japan’s economic strength was at its apex. China, since then has taken over Japan in 2011 as the world’s second largest economy and now widely noted to pose a serious challenge to the United State to be the world’s largest economy. While to some, China’s economic super power status is a foregone conclusion. Carl Walter and Fraser Howie examine the intricate mechanics beneath the façade and enlighten the intricate a web of political and financial entanglements that exists between the Communist Part of China (CPC) and the financial institutions that forms the economies foundation.

Carl Walter and Fraser Howie have extensive knowledge of the Chinese economy based on their long professional experience working in the middle kingdom. This is seen throughout the book as it is littered with facts on the history of the financial reforms, beginning with Zhu Rongji in the 1908s to the current personalities that lead the giant state owned financial behemoths. The view they show is that of a façade that was made to impress and imprint the view to outsiders, that China is an unstoppable force in the 21st Century.

Underneath the cover, the authors shows the flaws of the institutions which serve as the pillars of the system. From the lack of supervision and capital cushion in the major state banks which are crucial to the wider economy, to their conflicting governance goal of sustain the will of the CPC rather than its shareholders.

They also present a view of the stock market which replicates the Wild West of America in the 1900s where transparency and accountability is at best minimal. In addition to the stock market, the authors examine the stalling of reforms in central bank interest rate mechanism, exchange liberalization, and buildup of restrictions on foreign investment. The very lifeblood of what made China great today.

While economic liberalization since the 1990s and China’s entry to the WTO in 2001 has enabled its economy to growth at a phenomenal rate. Financial liberalization has been stalling and in some instances reverting to the planned economic philosophies of the 1960 and 1970s. The issue with policy stagflation under a fragile financial system is it could be a hidden risk that will eventually pose a systematic risk to the whole economy. One could argue that financial liberalization is an important area to be examined as the author shows, the current financial regime is simply infantile. The over reliance on the large state banks for funding, which themselves are thinly capitalized could be a liability under crises conditions.

Under an unforeseeable crisis, the opaqueness of the institution and its relationship with each other and the government would result in similar issue during the height of the GFC, where no one knows their true exposure to Lehman Brothers. The system would simply freeze. This is more acute in the Chinese system as the OTC bond market is in its infancy and a significant proportion of state company funding is delivered by the banks itself. If anything happen to these thinly capitalized banks, it would pose a sever risk to the wider economy.

Red Capitalism contains numerous stories of internal political maneuvering within the CPC for power. While the book is well researched and detailed explanation of the largest financial institutions and their relationships with each other. Beginner readers without background could have difficulty in track of the development of the financial system into the present form. But the complexity would also confuse market professionals as the picture is bordering to the detail and complexity of CDO’s. Except in this instance, the mind numbing complexity prevails throughout the whole system.

From reading the book, the reader forms an idea that there are essentially two economics in China, one is the private and the other the state owned institutions in which the CPC controls. The CPC uses all the tools it has over the private sector to ensure that its own monopolies in banking, telecommunications and transport will not be encroached by the private sector. This notion is similar to the viewpoint forwarded by Ian Bremmer in ‘The End of the Free Market'. The primary difference between the two economies is that one controls the arteries of the economic systems while the other is at its mercy. The reader’s final impression is that the strength in the goliath is more vulnerable than you realise.

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