China government's crisis of legitimacy

Tuesday, May 10, 2005


CHINA HAS BEGUN to tip its hand as to how it plans to unravel a Gordian knot of social, financial and political problems - any one of which could be life-threatening to the communist government in Beijing.

The revelation came April 27, when a China Banking Regulatory Commission official said leaders are examining ways to protect the country's banking sector against foreign competition, while - at least for now - still honoring its commitments under the World Trade Organization.

Though Shi Jiliang, the vice chairman of the CBRC, was careful to emphasize that China's WTO commitments are not in doubt, his discussion of achieving "an appropriate level of protection for Chinese banks" and taking efforts to "reduce excessive competition between foreign and Chinese banks" could hardly be lost on Beijing-watchers waiting for the government - which faces a crisis of legitimacy on multiple levels - to signal its next move.

As the situation stands now, any credibility the government gleaned from Marxism, Maoism or communism has long since faded, and the Communist Party remains in power only by dint of its ability to deliver economic well-being to the masses. Its chosen delivery mechanisms are state-owned enterprises - government-run companies that directly employ more than half the nation's urban dwellers. These vastly bloated and unprofitable companies are kept "viable" through subsidies and cheap loans, regularly injected by China's state-owned banks.

And therein lies the rub - for China, its banks and the WTO as well.

By any unbiased definition - and as recently as two years ago, even in the opinion of the government - the state banks are all moribund. Their total portfolio of (intentionally given) bad loans amount to somewhere between one- and two-thirds of China's gross domestic product, the highest ratio of any major economy in human history. Should that flow of loans be interrupted, the banks would crumble, the SOEs would crash, and China would burn in flames of economic catastrophe and social unrest.

The end of China's five year phase-in to full WTO membership - scheduled to arrive in December 2006 - is the very thing that could interrupt that life-giving flow of deadly loans.

At that point, all restrictions on foreign participation in the Chinese banking sector will fall away. And if Beijing allows this to occur as envisioned by the WTO, foreign banks would quickly attract the bulk of China's private savings, which now are forcibly funneled into the state banks and thence to the SOEs.

Currently, foreign access to China's financial world is thin, restricted as it is to local currency transactions in 18 cities. But even this limited access has led to the formation of some 220 foreign bank offices in China and totaled business worth 108.3 billion yuan ($13 billion) at the end of 2004. These foreign banks already hold 12 percent of all lending business in Shanghai, a rate of increase that Shi calls "unexpectedly [read: disturbingly] fast." Full competition would send Chinese money to the foreign banks in droves, and once foreign currency [read: U.S. dollar] operations are allowed, capital flight will reach mountainous proportions.

Hence, Shi has signaled that China will abrogate its commitments to permit banking competition, in order to assure the continued existence of the government. A choice between China's WTO commitments and the continued survival of the government is no choice at all.

There is certainly something to be said for preparation. Foreign bankers - who have been singing China's praises for years - have a vested interest in maintaining the Chinese hype, since they turn profits as money moves into or out of China.

But for these bankers, access to China's hundreds of millions of savers is the Holy Grail. A sudden split between Beijing and those who thus far have been singing in the choir would signal not the beginning of the end, but the end itself - for once the choir realizes it has been had, it is only a matter of moments before the entire congregation of investors speeds for the door.

Peter Zeihan is an analyst with Strategic Forecasting Inc., a Texas-based intelligence firm that provides corporations, government and individuals with geopolitical analyses and forecasts. Its work is often distributed on national press syndicates. Its Web site is This article appears with the company's permission.