Reviewed by Benjamin A Shobert
For a brief period in the late 1990s and early 2000s, it was possible - even fashionable - for critics of China to write polemic accounts predicting the country's imminent demise.
The seemingly impossible task of equitably lifting almost a billion still-impoverished Chinese out of poverty, the central government's dangerous dance with nationalism - testing wounds from World War II still not healed - and the country's corrupt bureaucracy, all, and even more still, seemed perfectly reasonable concerns that would cause China's growth to stop, and the country to again implode.
But in the time since most of these books were written, it was not China's economy that imploded, nor China's tenuous embrace of
For a brief period in the late 1990s and early 2000s, it was possible - even fashionable - for critics of China to write polemic accounts predicting the country's imminent demise.
The seemingly impossible task of equitably lifting almost a billion still-impoverished Chinese out of poverty, the central government's dangerous dance with nationalism - testing wounds from World War II still not healed - and the country's corrupt bureaucracy, all, and even more still, seemed perfectly reasonable concerns that would cause China's growth to stop, and the country to again implode.
But in the time since most of these books were written, it was not China's economy that imploded, nor China's tenuous embrace of
nationalism that provoked unnecessary conflicts. No, it was the American economy and political system that managed to do both.
Were each of these criticisms, whether they attempted to shine light on China's culture or economy, the country's history or politics, simply wrong? Hyperbole and rhetoric may have been the foundational errors of many of these critics, as they attempted to read too much meaning into the sort of internal complexities and contradictions that plague any country and a developing one even more so.
Or was it simply a matter of timing; will those structural flaws ultimately handicap China? Painting with too broad a brush may be partially to blame, an error more likely made by those who fundamentally disbelieve in China's potential and promise, who distrust that the country's Marxist-Leninist past could be somehow molded into a real economic miracle.
This sort of over-reach, especially in the face of America's own domestic malaise, makes the work of authors such as Carl Walter and Fraser Howie in their new book Red Capitalism: the Fragile Financial Foundation of China's Extraordinary Rise that much more valuable. Limited in scope to the question of China's financial system, Walter and Howie's at times technical analysis of the country's debt market manages to use a very targeted evaluation of the country's financial system in ways that lead the reader to ask much bigger questions, while at the same time also accommodating the authors' genuine respect for China's economic success story.
Walter and Howie believe that China's economic miracle cannot, and should not, be understood without first an appreciation of the jumbled and intertwined motives, players and mechanisms that comprise the country's financial markets. From their perspective, most important are Beijing's motives for empowering China's financial system.
As any visitor to China can admit, the country's political system and its seemingly free-wielding embrace of Western capitalism, is a confusing and - at times - intoxicating experience. Early into a personal experience traveling China, Americans knowledgeable about Beijing's ongoing suppression of opposing voices and its uneven record on religious freedoms run smack into a corner Best Buy or Starbucks, and seeing in Shanghai what they can find in Tampa are left with profound confusion about what really animates and defines China.
These sorts of externals - the transplanted Western hotels, restaurants and retailers - lead many outsiders to assume that, whatever differences might exist between China and the US, they are matters that time and China's ongoing development will resolve.
But Walter and Howie see deeper disconnects, as evidenced most directly in the actual motives behind Beijing's tenuous accommodation of the country's financial markets. According to the authors, China's embrace of the free market is a means to an end, and the end is simply put to maintain their political power: "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." (p 10)
This relationship has served China's political class, and as the authors are quick to point out, the 300 million Chinese who have been lifted from poverty in the last several decades, quite well. But to attract the sorts of long-term investment by outsiders that China needs in order to improve the quality of life of its billion still-impoverished citizens, Fraser and Howie question whether the country can continue to walk such a fine line.
They point towards the country's lack of underlying transparency, not only related to the role of the Party in decisions made, or strategies pursued by, State Owned Enterprises (SOEs), but in disclosure of the liabilities from both the public and private sectors within China. Writing about the matter of how China's financial markets value risk, they state:
The engine at the heart of the debt markets is the valuation of risk and this is missing in China because the Party controls interest rates. Similarly, the heart of a stock market is the valuation of companies and this is also missing in China because the Party controls the ownership of listed companies. Private property is not the central organizing concept of the Chinese economy; rather, the central organizing concept is tied to control and ownership by the Communist Party. Given this basic premise, markets cannot be used as the means to allocate scarce resources and drive economic development. This role belongs to the Party which, to achieve its own ends, actively manipulates both the stock and debt markets. (p 147)The net result of this mixed model is that China is trying to have it both ways: the capital from outsiders, which drives domestic investment, but with only a cosmetic head-nod to the sorts of transparency, and ultimately accountability, which comes with open markets. The awkward combination is necessary so that Party functionaries can redirect capital at their whims, absent either disclosure of their involvement or the sort of rationalization mechanisms which are necessary for capitalism to work.
On this point, the authors write, "An inherently conservative political class, whose natural instinct is to control, will not easily invite those it cannot easily control to participate actively in its domestic debt markets. But, as appearances have to be preserved, there will always be slight movements toward market opening. But there will be no true opening." (p 108) The consequence of this uneven embrace of market-makers? Capital deployment is likely chronic overcapacity in certain key industries, and likely excessive infrastructure building - both of which are problems that could soon become evident.
Anticipating that some readers may want to point towards China's burgeoning stock market as further evidence of the country's commitment to financial reform, Walter and Howie are quick to point out that even this traditionally very powerful capitalist tool is beset by the Party's agenda:
If one looks at incremental capital raising, it is obvious the stock markets in Hong Kong, Shenzhen and Shanghai are an afterthought ... in the stock markets as well, the huge deposits placed by institutional investors seeking share allocations in the primary market are also funded by loans from banks. In China, the banks are everything. The Party knows it, and uses them as both its weapon and its shield. (p 29)Where in genuinely capitalist economies the equity and debt markets are part of, but not wholly encompassed by, the banking system, in China no such distinction can be made: the bank is the state, and vice versa.
This raises the question of how China's financial system will withstand a crisis. It is possible Beijing's ability to exert almost complete control over the banking system, currency and equity markets would be benefits. Unlike truly capitalist economies, in the throes of a serious systemic banking collapse, China's government can play a much more direct and heavy-handed role. But such a response would have to be short term, lest too-long and too-great a role by the Party signals outsiders that China's financial markets are fundamentally flawed, realms where traditional valuation techniques no longer apply.
Acknowledging the underlying demographics which will continue to power China forward, the authors of Red Capitalism write, "Given China's geographical size and huge population, it is unlikely that its economy will grind to a halt in the way Japan's did after its magnificent run in the 1980s." (p 210)
In the midst of a book largely critical of China's financial system, the authors manage to always acknowledge the real progress made by China's governing party and the underlying forces which should continue to make the country an attractive market. In this spirit, the book's treatment of China's financial market always manages to be reasonable without resorting to rhetoric.
Towards the end of the book is one of the more interesting and provocative conclusions reached by Walter and Howie on what many in Washington believe is the most important point which should drive US-China economic dialogue: the valuation of the yuan (renminbi - RMB).
China's leadership has looked at the economic destruction wrought by the Asian financial crisis of 1997, and Japan's ongoing battle with economic stagnation and come to a simple conclusion: they were both the result of countries that lost control of their currency.
At their core, Beijing's economic team simply will not relinquish this lesson, and those in Washington who insist on making it front and center are setting both countries up for a magnificent disagreement. Writing on this, the authors say:
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. (p 210)Very early in Red Capitalism, Walter and Howie write, "China's banks look strong, but are fragile; in this, they are emblematic of the country itself. The Chinese are masters of the surface and excel at burying the telling detail in the passage of time." (p 27)
As 2011 begins, two questions weigh heavily on policy makers: first, will the American political system prove capable of an adult conversation about the necessary choices we must make and second, how will China's political system respond to an economic shock that is likely to come from within their own borders?
If Walter and Howie are right, China may be approaching a period when it can no longer hide the systemic flaws in its banking system; the more profound and problematic question the authors of Red Capitalism want their readers to ask is what this means for China as a whole. The answer will likely impact not just the Chinese, but people around the world as well.
Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise by Carl E Walter and Fraser J T Howie. Wiley (February 15, 2011). ISBN-10: 0470825863. Price US$29.95, 256 pages.
