New York | In this issue of The Institutional Risk Analyst, we ponder the latest developments in the world of secured finance. But first we thank those of you who have subscribed to our new premium service, including The IRA Bank Book Q3 2020 quarterly industry survey, which posted earlier this week.
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This week we ponder the world of US-China relations. Regardless of who wins the White House in November, the US posture towards Beijing is unlikely to change – especially since the Chinese seem quite deserving of foreign criticism. From the handling of COVID to the South China Sea to military clashes with India to Hong Kong and growing repression internally, China is at odds with the world.
The Trump Administration’s confrontation with China has been long overdue, but it is also a function of a lot of accumulated agendas in Washington, agendas that may not be well-informed on China’s political economy. Trade wars are yesterday’s news in the great age of decoupling and great national economic competition a la the period after WWI.
“It is critical that this country not use apps that are made in China,” White House trade adviser Peter Navarro said in an interview. But the Trump White House has not yet constructed a comprehensive approach to China’s financial strategy to match the counter-attack on trade and intellectual property. Merely imposing sanctions is not a policy.
Reflecting the anti-China evolution of Washington think, Clyde Prestowitz writes in The American Conservative that: “Beijing was never going to democratize because of open markets. They have merely used them to push their authoritarian designs.” He continues in a significant revision to US expectations of the China relationship:
“These cautions are the remnant of the great fantasy that swept the free world in the wake of President Nixon’s 1972 “opening of China” and Chinese leader Deng Xiaoping’s 1978 decision to experiment with market economics. We imagined China on a capitalist road that would inevitably lead to liberal politics and even democracy.”
Prestowitz apologizes for being part of the pro-China lobby in Washington, a legacy of western self-delusion about the nature of power in Asia. As China lurches towards another totalitarian extreme under Xi Jinping, any hopes of democratic opening must be put aside. Indeed, the modern Chinese state under Xi is tracking in the very opposite direction as that described by Mao Zedong in 1945 when he wrote about democracy in China from the perspective of the Chinese Communist Party (CCP):
“A free and democratic China will be this kind of nation: all levels of government, including the central government, are created by general and equal secret balloting and are responsible to the people who elected them. It will implement Dr Sun Yat-sen’s three principles of democracy, Lincoln’s principle of ‘of the people, by the people, and for the people’, and [Franklin D.] Roosevelt’s Atlantic Charter. It will assure the independence and unity of the nation and cooperate with all democratic powers.” (Excerpt from Takeuchi Minoru, Collected Writings of Mao Zedong, Tokyo: Hokubosha, 1970-1972).”
Following the track of Xi Jinping’s accumulation of authoritarian control in China, it is clear that information technology and monetary mechanisms will be two crucial levers whereby the CCP will control its people, both in China and around the world in the vast diaspora of different nationalities within China. As the US and China do indeed decouple, understanding the financial dimension of the next leg of China’s economic strategy is important for Washington.
First, China is already using IT to profile and discipline individual behavior by its citizens. Everything from employment to access to schools and health care to travel are now part of a political profile of every citizen maintained by the CCP and the state security apparatus. If you complain of corruption by local officials, your score can be changed instantly. With the press of a button, you cease to exist.
China under Xi Jinping is becoming the embodiment of George Orwell’s “1984” nightmare fueled by 21st century technological tools. Facial recognition, for example, enabled with a lot of stolen western technology, enables the Chinese state to track the movements of its citizens and include this public surveillance in its overall profile of each citizen. The level of control enjoyed by the CCP is illustrated by the harvesting of human organs from the living bodies of political prisoners.
The role of finance in China’s development and the CCP’s adoption of new authoritarian controls is a vital piece of the puzzle. By driving China towards a cashless society, the CCP and state security services can use access to electronic cash and payments as a mechanism for reward or punishment. When cash is eliminated, the state that controls the means of exchange – call it currency – controls all.
As financial reform becomes the next leg of the CCP’s continuing drive to protect its political monopoly in China, the fight with Washington over allowing Chinese firms to list their shares in the US takes on significance.
Many Chinese firms refused to follow US requirements regarding audit results, putting them in violation of exchange and SEC rules. But the threats by the US to shut out Chinese firms remain just threats in an election year.
"Trump will get louder and louder on China before the election, but all of these things will take years to phase in after the election," notes veteran China watcher Leland Miller founder of China Beige Book. "But many Chinese companies need access to the US markets because they cannot raise significant money on a Hong Kong exchange. Dollar stability is required for their system to work."
While US actions to address are correct, attracting more volumes to Chinese exchanges serves the interests of the CCP. Even as the US restricts access to US exchanges, billionaire Jack Ma’s Ant Group is poised to simultaneously list in Hong Kong and Shanghai. Bloomberg News reports Ant is gunning for a valuation of $225 billion, making it the world’s fourth-largest financial company.
If you appreciate that the benefits available to CCP members for self-enrichment have been greatly reduced in recent years compared with, say, the first decade of the 2000s, then you understand the problem. Xi Jinping needs to increase the cash flow to communist party cadres in order to maintain control in the 2020s. Reforming the financial system is the perfect canvas for eliminating enemies and generating cash -- especially from the important offshore Chinese community.
Following efforts in Russia to repudiate the worst aspects of Joseph Stalin’s rule of terror, in February 1956 Mao Zedong invited criticism of the Chinese Communist Party’s policies. He used a famous slogan from Chinese classical history: “Let a hundred flowers bloom, and a hundred schools of thought contend.”
Xi Jinping is hoping to let 1,000 IPOs bloom in newly subjugated Hong Kong and the less sophisticated Shanghai. This, he believes, will reinforce China's growth and also strengthening authoritarian controls. Over time, Beijing hopes to create a regional currency regime bolstered by local currency stock and debt issuance that is large enough to meet the CCP’s requirements for economic growth and employment, but not big enough to threaten party rule. The all-important criteria is the continuance in power of the CCP.
In order for China to even consider challenging the US for dominance as the world’s reserve currency, Beijing would need to embrace a level of openness and transparency that would also threaten CCP political control. In order for the yuan to supplant the dollar, China would need to embrace the democratic aspirations of Mao in the 1950s.
Of course, after flirting with democracy as a means to power, Mao too embraced authoritarian methods of control and the Cultural Revolution. The cost of the Cultural Revolution was 20 million killed in the 1960 and 1970s and incalculable damage to Chinese society.
Look for China to build a financial prison behind a firewall constructed to control the people of China and ensure the survival of the CCP. The period of collective leadership that followed Mao’s death in 1976 is properly seen as an anomaly but was never about democratic opening. Now Xi is taking China's system of personal and political control to a new level under the guise of financial modernization.