Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise [Hardcover]

Carl E. Walter (Author), Fraser J. T. Howie (Author)

Book Description

Publication Date: February 15, 2011

In Red Capitalism, Carl Walter and Fraser Howie detail how the Chinese government reformed and modeled its financial system in the 30 years since it began its policy of engagement with the west. Instead of a stable series of policies producing steady growth, China's financial sector has boomed and gone bust with regularity in each decade. The latest decade is little different. Chinese banks have become objects of political struggle while they totter under balance sheets bloated by the excessive state-directed lending and bond issuance of 2009.

Looking forward, the government's response to the global financial crisis has created a banking system the stability of which can be maintained only behind the walls of a non-convertible currency, a myriad of off-balance sheet arrangements with non-public state entities and the strong support of its best borrowers--the politically potent National Champions--who are the greatest beneficiaries of the financial status quo.

China's financial system is not a model for the west and, indeed, is not a sustainable arrangement for China itself as it seeks increasingly to assert its influence internationally. This is not a story of impending collapse, but of frustrated reforms that suggests that any full opening and meaningful reform of the financial sector is not, indeed cannot be, on the government's agenda anytime soon.

--This text refers to the Kindle Edition edition.

Editorial Reviews

Amazon.com Review

Product Description
In Red Capitalism, Carl Walter and Fraser Howie detail how the Chinese government reformed and modeled its financial system in the 30 years since it began its policy of engagement with the west. Instead of a stable series of policies producing steady growth, China's financial sector has boomed and gone bust with regularity in each decade. The latest decade is little different. Chinese banks have become objects of political struggle while they totter under balance sheets bloated by the excessive state-directed lending and bond issuance of 2009.

Looking forward, the government's response to the global financial crisis has created a banking system the stability of which can be maintained only behind the walls of a non-convertible currency, a myriad of off-balance sheet arrangements with non-public state entities and the strong support of its best borrowers--the politically potent National Champions--who are the greatest beneficiaries of the financial status quo.

China's financial system is not a model for the west and, indeed, is not a sustainable arrangement for China itself as it seeks increasingly to assert its influence internationally. This is not a story of impending collapse, but of frustrated reforms that suggests that any full opening and meaningful reform of the financial sector is not, indeed cannot be, on the government's agenda anytime soon.

Q&A with Authors Carl E. Walter and Fraser J. T. Howie
You have been writing together about the Chinese financial system for over a decade, what are the biggest changes you have seen?
The obvious one is just the shear size of the markets and the economy. At the time of the Asian Financial Crisis in 1997 China’s foreign reserves were about 150 billion US$. Now they are twenty times bigger. The number of listed companies has more than doubled, the daily trade volumes in Shanghai have increased ten-fold and only a handful of government bonds had been issued. Now there are thousands of different debt products. Everywhere you look the numbers just seem to get bigger and bigger, but that doesn’t tell the whole story. All the growth comes without the expected development: Chinese markets remain primitive in spite of their size.

How do the markets remain primitive? Surely the growth brought development?
China has done a fantastic job at building the market infrastructure. Trading and settlement systems and all that goes along with what we would call a modern market is there, but in nearly every case, the market has been warped or restricted by the government. Take the bond market, the government sets interest rates and even the rates at which bonds can be issued. No bond investor considers the possibility of default of the issuer because the assumption is that the government will step in to cover the risk. What then does a bond market do if credit risk and interest rate risk have been removed? In the stock market, the state still remains the largest holder of shares and has majority ownership of all the major companies. No one seriously expects the state to ever sell down their holdings, so the market doesn’t price companies but shares. The stock market fundamentally should be about pricing capital and companies, but since the state owns the companies, the market isn’t the place where company control and ownership are traded.

Has the entry of foreign investors, banks and brokers made a difference to the markets?
In a word, no. There have been a broad range of developments and programs to allow foreign capital into the domestic markets, but foreign onshore operations remain very small and tightly controlled. Foreign stock investors have only been allowed to invest less than 20 billion US$ into Chinese domestic stocks over the past decade; the foreign banks’ share of the banking market has fallen. Only now are we starting to see foreign capital get into the domestic bond market. China bulls point to this as progress and development, but the pace of change is glacial and the returns limited; foreigners hold only 1.77 percent of Chinese financial assets.

In Red Capitalism you focus on the banking sector. Why was that?
It is true that the restructuring of state enterprises in order to sell shares and raise capital has transformed China’s corporate sector. It is also the most glamorous area of finance. The truth, however, is that equity capital has provided in any given year less than 10 percent of all corporate capital raised. The real source of corporate finance in China was and remains the banks, which are the very heart of the entire system.

The Western financial system has been shown to be very imperfect, but does the Chinese model offer an alternative?
China’s bankers have said publicly that after the global financial crisis they no longer have a model to follow. The reason its banks emerged safely from the global turmoil is because they were walled off from it behind an inconvertible currency and tiny international credit exposures. In today’s world of global trade, banks must be more than simply purveyors of cheap capital to domestic companies. China’s banks have yet to reach out to assist its National Champions in their expansion overseas. So it is inaccurate to compare the two financial systems.

You talk about the fragile foundation of China’s rise, how do you think that will play out over the next twenty years? Will China become a superpower like America?
China’s weaknesses are very real and the problems will take a lot of determined effort to solve. Perhaps some of them can’t be solved without a break with the past, but we want to downplay the idea that collapse is imminent. The Chinese government is not getting rid of its currency controls any time soon, so they will be able to cushion the impact of any downturn reasonably well. The weakness of the system will play out through continual misallocation of capital and resources. Investment will follow political whim, resulting in tremendous waste and corruption. China will continue to grow and get bigger, so maybe the economy will be bigger than the states, but it will not be able to exert the same influence that the US can and will continue to do--unless the government embraces real reform across a broad spectrum of issues.

Review

“...China is bent on superpower rivalry; reserve currency status for the renminbi is a glint in the party’s eye. Red Capitalism puts a powerful case that [China’s] economy and financial system are not fully equipped to support such aspirations.”
– Financial Times, January 2011

“So pervasive has this view [that the 21st century is China's for the taking] become that any effort to examine whether it's actually true comes as a breath of fresh air. "Red Capitalism" is such a work. Authors Carl E. Walter and Fraser J.T. Howie, both investment bankers, argue that China isn't so different from other economies nor so immune from normal economic laws as cheerleaders argue. An examination of the financial system—or "how China's political elite manages money and the country's economy," as the authors put it—offers a useful lens through which to view much broader issues.”
– The Wall Street Journal, January 2011

“[The authors’] ongoing research is an indispensable resource for those seeking the reality behind the often nauseating and sycophantic hyperbole surrounding China’s capital markets.”
– China Economic Quarterly, December 2010

“In their new book, "Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Riser Carl E. Walter and Fraser IT. Howie paint a troubling portrait of the Chinese economy and financial system. Despite the nation's mind-boggling growth and images of gleaming skyscrapers and luxury cars, the authors say the Chinese growth model is flawed and fragile, and they warn about substantial risks accumutating in its banking system.”
– The New York Times & International Herald Tribune Asian edition, January 2011

“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.”
– Asia Times Online, January 2011

The most important financial book of the year."
— James Grant, editor, Grant's Interest Rate Observer

“Red Capitalism peels back the facade of China's economy and reveals how the dominant role of the state has led to enormous financial leverage and endemic malinvestment. China's major role in the global economy makes Red Capitalism required reading for any financial industry fiduciary.”
— Mark L. Hart III, Chairman, Corriente Advisors, L.L.C.

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Product Details

• Hardcover: 256 pages
• Publisher: Wiley; 1 edition (February 15, 2011)
• Language: English
• ISBN-10: 0470825863
• ISBN-13: 978-0470825860
• Product Dimensions: 1 x 6.3 x 9.4 inches
• Shipping Weight: 12.8 ounces
• Average Customer Review: 4.1 out of 5 stars  See all reviews (22 customer reviews)
• Amazon Best Sellers Rank: #482,315 in Books (See Top 100 in Books)

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Most Helpful Customer Reviews

31 of 34 people found the following review helpful

3.0 out of 5 stars Opacity Hovering Over a Sea of Red Ink Made in China March 21, 2011

By Serge J. Van Steenkiste

Format:Hardcover

Carl Walter and Fraser Howie shine ruthlessly, their projectors, on China's still-opaque, stunted capital markets. The authors demonstrate convincingly that China's major banks have been for the most part simple financial utilities directed by the Chinese Communist Party (Party) to extend whatever loans are necessary to achieve its economic growth goals. Chinese households' high savings are the foundation of the banks' capacity to lend. Walter and Howie wonder what will happen to this bank funding if the Chinese households learn to borrow and spend with the same enthusiasm as their American counterparts have done. The authors show clearly that Chinese households are poorly rewarded for their thriftiness due to inadequate yield returns in light of the prevailing inflation rate. Only stocks and real estate, both highly speculative and risky in nature, offer Chinese households investment opportunities which can possibly allow them to beat inflation.

The clean-up of non-performing loans (NPLs) and the ensuing recapitalization of China's major banks are a recurring feature in the management of the country's major banks by the Party. The veneer of credibility that the (Western) financial community has provided to China's major banks cannot hide the fact that these banks are subservient entities not only to the Party, but also to the major state-owned enterprises (SOEs), the greatest beneficiaries of the financial status quo. Walter and Howie wonder whether the major SOEs control the Party due to their great economic and political power. The authors point out correctly that the non-state companies can only thrive in sectors such as consumer, food, certain areas of high-tech, pharmaceutical, and other light industrial sectors in which the Party and SOEs have had little interest. Allowing direct, fair competition from the non-state sector would oblige SOEs to shape up without the support of a complaisant financial system.

Furthermore, Walter and Howie debunk the myth that China's public debt burden is low. Central government obligations, local government obligations, and NPLs already represent over 75% of China's GDP. The authors remind their audience that the cost of public debt interferes increasingly with growth the more that this cost is above 60% of GDP. China's unfavorable demographics will only make this challenging situation worse in the coming decades. However, Walter and Howie believe that China's use of debt can continue for a long time due to the country's still opaque economic and political system. In addition, the authors remind their audience that the Party is keen to keep the renminbi as undervalued as possible, regardless of the relentless pressure of China trading partners. The Party does not forget what happened to Japan after the country freed up the yen to appreciate and deregulated its financial markets. Japan has not yet fully recovered from its wild asset bubble burst that occurred in 1991.

Walter and Howie call for their emergence of a strong leader who can bring the reform of the Chinese capital markets back on track. The authors deplore ad nauseam that former Premier Zhu Rongji's thorough financial reforms are unraveling under the pressure of special interests such as SOEs.

In summary, Walter and Howie offer their readers an opportunity to go beyond the hype by uncovering the lid on China's still-opaque, stunted capital markets.

31 of 34 people found the following review helpful

4.0 out of 5 stars Great, but wow can you say huge Zhu Rongji crush? February 27, 2011

By Law student

Format:Kindle Edition|Amazon Verified Purchase

I really enjoyed the description of China's financial setup. I think this book makes a relatively dry sounding subject quite enjoyable and I finished reading this book in about a day -- the only real concerns I have are two 1) Man the writers have a giant man crush on ex-Premier Zhu. For about 90% of the book, Zhu is the peerless reformer of the financial system...and then suddenly in the penultimate chapter Zhu's reforms are made to appear as the fundamental cause of the deepening corruption among China's 'princeling' party. 2) Despite the relatively grim description of the financial system and the growing corruption in China the writers, in less than a page, conclude that "China will not follow Japan's path because its geographic and population size, and the constrained nature of its banking system" which I must admit did not make much sense to me, malinvestment is malinvestment. I am also unsure about their argument that because it took 20 years for Greek perfidy to come to light regarding their financial and fiscal state the PRC's opaque system is safe from a crisis of confidence.

Still, this is a great book and I would definitely recommend it to anyone even remotely interested in China...and by extension the rest of the world.

10 of 10 people found the following review helpful

5.0 out of 5 stars Another Book Review from the Aleph Blog September 6, 2011

By David Merkel

Format:Hardcover

Chinese Capitalism isn't magic. Some parts are a little sketchy. There are several difficult to sustain aspects of Chinese economic/financial policy.

1) The banks are basically extensions of the Chinese government.

2) Loans that the banks make are often politically motivated, made to those connected within the party; many of those loans are not economic, and the loans don't perform.

3) Asset management companies are formed to absorb the bad debts when they become a risk to the banks. These are funded by the Ministry of Finance, which effectively shifts losses back to the government in an indirect way, often via the People's Bank of China.

4) China has massive foreign currency reserves, but the ability to use them domestically is limited.

5) Since 2008, forcing the the banks to lend has accelerated. In understanding the indebtedness of the Chinese nation, one must aggregate and net the debts of the banks and other financial entities sponsored by the government. In the US, that would mean adding and netting the debts of the GSEs.

6) The financial markets of China are bank-centric. The bond market does not play much of a role, except that the banks absorb many of the bonds, sometimes at negative interest spreads.

7) Chinese finance can be very complex, with difficult-to-understand flowcharts for cashflow and promises, some of which hide bad debts eventually absorbed by the PBOC. They are another example of how structured finance can obscure economic results.

8 ) When companies went/go public in China, the rewards often disproportionately went/go to party leaders and friends/family thereof.

In short, what privatization has happened in China has benefited those connected to the Party, while the banking sector the economy is the slave of the Government, despite the offering of shares to the public.

I recommend this book highly, and think the authors did a good job in being realistic about China and its financial economy. China has a weird economy. They could subsidize and own businesses explicitly, but instead, the subsidies are hidden inside financing.

But wait, what is the endgame here? If all of the banks are mere extensions of the government, once inflation gets large enough, the Chinese government will have to modify/abandon what they are doing. China steals from its consumers (financial repression) to aid its producers, who in turn give money to the Party, with whom the producers are in league.

Quibbles

None.

Who would benefit from this book: If you want to understand the Chinese economy, you will like this book.