C&B Notes

Party First, Last, and Always

Mercantilism is alive and well in China — the ruling party wants capital to flow into China but not out. This arcane economic idea is amongst a mix of issues at play in China, from the Communist Party’s overriding goal of stability to avoid uprisings, to the consolidation of power and fealty at the top of the Party, to the desire of the wealthy to get assets and currency outside of China, to favoritism of selected businesses and businessmen (Chinese Princelings = Russian Oligarchs), etc. China is a market of great interest to us and its impact on the global economy is enormous, but we struggle with how to deal with the political risks of the existing structure, including the ever-present real possibility of a revolution.

As more than $1tn left the country over the previous 18 months amid a flurry of large overseas acquisitions, a sense of crisis grew within the party.  Technocrats in Beijing had already prepared the ground to take action.  In December, they had managed to link the phrase “national security” to the concept of financial risk at the annual agenda-setting economic work conference.  Backed with the reserves figures, they were poised to strike against what they saw as the leading culprit — the new generation of highly acquisitive private Chinese companies.  These tensions within the system have exploded into the open in the past two months with the humiliation of some of China’s best-known and most well-connected private companies, which in recent years have acquired high-profile foreign assets such as New York’s Waldorf Astoria Hotel and French leisure company Club Med.  In an abrupt turn, a group of businessmen once lauded as the international face of China are now derided in state media as the instruments of systemic financial risk.  The private sector has been shaken by leaked documents, smears and the detention of China’s brashest businessman.

The seemingly technical issue of a drop in foreign exchange reserves has become a political weapon as President Xi Jinping tries to consolidate enough power to control his own succession.  Attacks on private financiers have allowed him to pick off the support base of rival factions.  “Private capital is welcome as long as it’s in the service of the [Communist] party,” says Fraser Howie, co-author of Red Capitalism and an expert in Chinese regulation.  This summer, “they’ve given a very, very strong tug on the leash that’s on everyone’s neck in China.”  The crackdown has allowed the technocrats to rein in some of the worst excesses of a mergers-and-acquisition boom that could have damaged China’s economy and reputation.  But it has also resulted in an arbitrary process that has left the private sector with no clear idea of what sort of activity is permitted and which has created mistrust among foreign companies looking to do deals with Chinese firms.

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In the weeks following his detention, property giant Dalian Wanda and two other companies that personified China’s rapid capital outflow over the past two years — airline-to-banking group HNA and consumer conglomerate Fosun — have been targeted by well-placed leaks and state media innuendo.  Together, the four accounted for nearly a fifth of China’s overseas purchases in 2016. HNA Group, Dalian Wanda and Anbang were among the top six buyers that year.  For the regulators, one of the specific concerns was that the money used for some of the overseas acquisitions had been raised through a number of potentially risky channels, such as high-interest shadow financing in China or overseas loans collateralized with domestic assets whose value might be artificially inflated.  Officials worried that in the event of a default, there might be no assets to pay off domestic investors.  Front and center among those concerns stood Anbang, the bold insurance company that had risen from seemingly nowhere to sixth in the Chinese out-bound M&A league tables in 2016.  Anbang had raised money by selling life insurance products that could be considered investment products in disguise (a typical shortdated universal life policy might mature in two to five years).  “They are not a normal company, Anbang,” says one senior US insurance executive.  “They were untouchable for political reasons so therefore they went into assets and investment practices that are anathema in the industry: long-term asset-liability mismatch, currency mismatch and unhedged.”

The regulators’ argument that shadow banking posed a national risk found an unlikely ally in China’s security apparatus.  Ordinary people who had lost money in high-interest products have taken to the streets in every province over the past few years.  Nothing captures the interest of the Communist party like a mass protest.  “Getting Xi’s attention on economic issues seems a matter of convincing him that they affect his core priority — national security,” says Jude Blanchette, who researches Chinese politics for The Conference Board.  “This is just good old bureaucratic politics 101.”

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