Red Capitalism

How did China transform itself so quickly? In Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise, Revised Edition Carl Walter and Fraser Howie go deep inside the Chinese financial machine to illuminate the social and political consequences of the unique business model that propelled China to economic powerhouse status, and question whether this rapid ascension really lives up to its reputation.

All eyes are on China, but will it really surpass the U.S. as the world's premier global economy? Walter and Howie aren't so certain, and in this revised and updated edition of Red Capitalism they examine whether or not the 21st century really will belong to China.

• The specter of a powerful China is haunting the U.S. and other countries suffering from economic decline and this book explores China's next move
• Packed with new statistics and stories based on recent developments, this new edition updates the outlook on China's future with the most cutting-edge information available
• Find out how China financed its current position of strength and whether it will be able to maintain its astonishing momentum

Indispensable reading for anyone looking to understand the limits that China's past development decisions have imposed on its brilliant future, Red Capitalism is an essential resource for anyone considering China's business strategies in today's extremely challenging global economy.

Preface to the Second Edition xi

Preface to the First Edition xvii

List of Abbreviations xxi

1 Looking Back at the Policy of Reform and Opening 1

Thirty years of opening up: 1978–2008 2

Thirteen years of reform: 1992–2005 10

The end of reform: 2005 15

China is a family business 22

2 China’s Fortress Banking System 27

Banks are China’s financial system 29

China’s banks are big banks 31

Crisis: The stimulus to bank reform, 1988 and 1998 33

China’s fortress banking system in 2010 41

The sudden thirst for capital and cash dividends, 2010 47

3 The Fragile Fortress 53

The People’s Bank of China restructuring model 56

The Ministry of Finance restructuring model 66

The “perpetual put” option to the PBOC 73

The new Great Leap Forward Economy 76

China’s latest banking model 82

Valuing the asset management companies 85

Implications 88

4 China’s Captive Bond Market 95

Why does China have a bond market? 98

Risk management 102

The base of the pyramid: Protecting household depositors 116

5 The Struggle over China’s Bond Markets 125

The CDB, the MOF, and the Big 4 Banks 126

Local governments unleashed 134

Credit enhancements 141

China Investment Corporation: Linchpin of China’s financial system 145

Cycles in the financial markets 158

6 Western Finance, SOE Reform, and China’s Stock Markets 163

China’s stock markets today 164

Why does China have stock markets? 168

What stock markets gave China 172

7 The National Team and China’s Government 185

Zhu Rongji’s gift: Organizational streamlining, 1998 186

How the National Team, its families, and friends benefit 196

A casino or a success, or both? 209

Implications 212

8 The Forbidden City 215

The Emperor of Finance 217

Behind the vermillion walls 220

An Empire apart 227

Have the walls been breached? 231

Cracks in the walls 235

Imperial ornaments 239

Appendix 245

Select Bibliography 249

Index 251

Carl E. Walter lived in China for twenty years and actively participated in numerous financial reforms. He played a major role in China's groundbreaking first overseas IPO in 1992, as well as the first listing of a state-owned enterprise on the New York Stock Exchange in 1994. He was a member of the Management Committee at China International Capital Corporation, China's first and most successful joint venture investment bank, where he supported a number of significant domestic stock and debt underwritings for major Chinese corporations. More recently, he helped build one of the most successful and profitable domestic security and currency trading operations for a major global investment bank. Fluent in Mandarin, he holds a PhD from Stanford University and a graduate certificate from Beijing University. He currently lives in New York where he acts as an independent consultant.

Fraser J. T. Howie studied Natural Sciences (Physics) at Cambridge University and Chinese at Beijing Language and Culture University. For nearly twenty years he has been trading, analyzing, and writingabout Asian stock markets. During that time he has worked in Hong Kong, trading equity derivatives at Bankers Trust and Morgan Stanley. After moving toChina in 1998, he worked in the sales andtrading department of China International Capital Corporation followed by a stint with China M&A Management Company. He has contributed to the SCMP, AWSJ, China Economic Quarterly,and China Economic Review as well as being a regularChina commentator on CNBC, BBC, Al Jazeera, and Bloomberg. Currently, he is a Managing Director at a leading Asia Pacific Brokerage firm in Singaporehelping international investors invest in both the Indian and Chinese markets.

In the space of just a few short decades, China has transformed itself from a nation scarcely able to cover the cost of sending its highest-ranking dignitary to speak at the UN to one with financial reserves numbering trillions of dollars. In Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise, Revised Edition, Carl Walter and Fraser Howie, experts in Chinese finance, tell the story of China's incredible ascension, how it got to where it is now, and what the future holds.

Exploring how China's financial institutions—from banks to corporations—and most importantly, the national Communist Party, shape the country's economic choices, development, and reform and what this means within China and for the rest of the world, the book examines whether or not the twenty-first century really will belong to China, calling into question the sustainability of the current system. Going deep inside the Chinese financial machine to illuminate the social and political consequences of the unique business model that has transformed the country into an economic powerhouse, Walter and Howie investigate whether the incredible gains of the last thirty-plus years really live up to their reputation.

While China has seemingly adopted a Western style of economic and commercial growth—complete with stock-listed corporations and a growing class of accountants, lawyers, and investment bankers—the reality is that China remains a Communist country, one in which the state can—and frequently does—step in to save struggling industries. In contrast to the common view of China as an unstoppable freight train of growth, Red Capitalism shows how the country's decades of development have been marked not by steady ascension but rather an ongoing series of booms and busts that many corporations would not have been able to weather without large-scale government intervention.

With new and expanded coverage of China's "Big 4" banks; why assigning credit ratings is still a problem; the rapid growth of Chinese national debt; and more, this fully revised edition of Red Capitalism is indispensable reading for anyone looking to understand the limits that China's past development decisions have imposed on its promising future.

Praise for Red Capitalism

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

"Red Capitalism peels back the faÇade 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.

"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 its economy and financial system are not fully equipped to support such aspirations." —Financial Times

"This book allows us to further deepen our analysis and prepare for the tumultuous events which impend." —Socialism Today

"Walter and Howie possess a rare depth of experience in the analysis of the Chinesefinancial sector. Their hard-hitting conclusions,based on a wealth of empirical research, will stimulate debate about the future of theChinese financial system at a critical point in its evolution." —Peter Nolan Sinyi Professor of Chinese Management, Cambridge Judge Business School, University of Cambridge

"Concise and erudite, Red Capitalism is a fantastic deep dive into China's structurally flawed financial system." —China Economic Review

"A penetrating analysis that demonstrates how hard it is to follow the old adage 'follow the money,' and how rewarding it is to understand what will really drive China into the future." —Christian Murck President, American Chamber of Commerce in China

"Walter and Howie put the Chinese financial system under the microscope to examine how an absence of leadership, institutional squabbling, and complacency have seen appetites for reform splutter out, replaced by stagnation and dysfunction. Theirs is a fascinating, entertaining, and necessary corrective to the hyperbole surrounding China's seemingly miraculous rise."—David Wilder Beijing Bureau Chief, Market News International

"Red Capitalism is an important addition to the reading list of any China-watcher."—The Hindu

"Red Capitalism is a superb guide to China'sfinancial labyrinth. It's a must-read for anyone who wants to understand the sources ofChinese economic power, and the threat posed by the nation's vast hidden debts."—Arthur Kroeber Editor, China Economic Quarterly

NAMED A BEST BOOK OF THE YEAR BY THE ECONOMIST