The Red Iceberg

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The Fall of the Com­mu­nist Dynasty and The Loot­ing of Chi­na touched on the wide­spread fraud that has become appar­ent, both in main­land and US list­ed Chi­nese com­pa­nies. I also showed that an extra­or­di­nary num­ber of the Com­mu­nist Par­ty and the mil­i­tary cadre  had mas­sive unex­plained wealth, with the Top 70 record­ing a net col­lec­tive worth of over $80 bil­lion. This week Bloomberg  was banned by the Chi­nese gov­ern­ment for report­ing the incom­ing pres­i­dents fam­i­lies assets at over $367M.

As Xi climbed the Com­mu­nist Par­ty ranks, his extend­ed fam­i­ly expand­ed their busi­ness inter­ests to include min­er­als, real estate and mobile-phone equip­ment, accord­ing to pub­lic doc­u­ments com­piled by Bloomberg.

Those inter­ests include invest­ments in com­pa­nies with total assets of $376 mil­lion; an 18 per­cent indi­rect stake in a rare- earths com­pa­ny with $1.73 bil­lion in assets; and a $20.2 mil­lion hold­ing in a pub­licly trad­ed tech­nol­o­gy com­pa­ny. The fig­ures don’t account for lia­bil­i­ties and thus don’t reflect the family’s net worth.

I explained how this net worth had come about by the imple­men­ta­tion of the Cadre cap­i­tal­ist sys­tem by Deng in the ear­ly 90s and how that evolved into a klep­tor­ca­cy.

To this we add the stand­off between the Chi­na and the US over account­ing stan­dards. This issue has been going on for a few years and there looks to be no res­o­lu­tion in sight. Chi­nese firms could be cut off from US cap­i­tal mar­kets by the end of the year says Patrick Chovanec  a pro­fes­sor at Tsinghua Uni­ver­si­ty’s School of Eco­nom­ics and Man­age­ment in Bei­jing, Chi­na. .

unless a com­pro­mise can be reached, there is a very real chance that U.S. secu­ri­ties reg­u­la­tors may end up employ­ing the “nuclear option”:  forcibly delist­ing every Chi­nese com­pa­ny cur­rent­ly list­ed on a U.S. stock exchange — such as Sinopec,, Chi­na Life, and Chi­na Uni­com.   It’s a poten­tial cat­a­stro­phe-in-the-mak­ing that few investors or politi­cians have giv­en any seri­ous thought to.

There is a high prob­a­bil­i­ty  that the Chi­nese sim­ply can­not com­ply with US require­ments because Chi­nese politi­cians and princelings would be impli­cat­ed in these mas­sive frauds , with over 200 com­pa­nies hav­ing list­ed in the US this would result in a mas­sive dis­lo­ca­tion of cap­i­tal when these com­pa­nies are forced to relist in Hong Kong. If as Paul Gillis , a Pro­fes­sor at Peking Uni­ver­si­ty’s Guanghua School of Man­age­ment con­tends the

PCAOB and the SEC make no progress. The issue becomes polit­i­cal and wide­ly known. Dereg­is­tra­tion becomes the only option and it is the PCAOB that pulls the plug. That then forces the exchanges to decide how to enforce their rules that require com­pa­nies to have audi­tors and audit­ed finan­cial state­ments in order to be list­ed. I expect in this sce­nario that the exchanges are forced to delist the com­pa­nies, and the scram­ble to Hong Kong begins.

On the 20th June, the SEC served for­mal requests on  the Chi­nese arms of all of the Big Four audit firms Chi­na Secu­ri­ties Reg­u­la­to­ry Com­mis­sion (CSRC) warned  the Big Four glob­al account­ing firms not to pro­vide audit records to over­seas reg­u­la­tors. Cur­rent­ly, Main­land Chi­nese affil­i­ates of the inter­na­tion­al audit firms have 130 clients list­ed on US stock exchanges with Deloitte (48 clients), PwC and KPMG (28 clients each) top­ping the list.

The real­i­ty is that Hong Kong hasn’t the capac­i­ty to re-reg­is­ter this amount of cap­i­tal, so the issue is like­ly to become a pow­der keg in a US elec­tion run up.  Will Oba­ma or Mitt be will­ing to stare down Chi­na on account­ing and audit stan­dards?

John Hemp­ton’s ABC of Chi­nese Klep­toc­ra­cy leads us to only one con­clu­sion

(a). The chil­dren and rel­a­tives of CPC Cen­tral Com­mit­tee mem­bers are amongst the ben­e­fi­cia­ries of the wave of stock fraud in the US,

(b). The response to the wave of stock fraud in the US and Hong Kong has not been to crack down on the per­pe­tra­tors of the stock fraud (so to make mar­kets work bet­ter). It has been tomake Chi­nese statu­to­ry accounts less avail­able to make it hard­er to detect stock fraud.

©. When giv­en direct evi­dence of fraud­u­lent accounts in the US filed by a large com­pa­ny with CPC fam­i­ly mem­bers as ben­e­fi­cia­ries or man­age­ment a big 4 audit firm will (pos­si­bly at the risk to their glob­al fran­chise) sign the accounts know­ing full well that they are fraud­u­lent. The audi­tors (includ­ing and arguably espe­cial­ly the big four) are co-opt­ed for the ben­e­fit of Chi­nese klep­to­crats.

The Chi­nese are refus­ing because they are pro­tect­ing Klep­to­crat rack­e­teers.

The prob­lem maybe that nei­ther side has room to move, US reg­u­la­tors and the ‘get tough with Chi­na brigade’ must move to pro­tect the via­bil­i­ty of US cap­i­tal mar­kets , while west­ern style audits may expose far to  many polit­i­cal­ly con­nect­ed klep­to­crats behind the Chi­nese audit cur­tain for them to give way. The Chi­nese reluc­tance to pro­vide infor­ma­tion may indi­cate that the frauds that have been uncov­ered to date are mere­ly the tip of a big Red Ice­berg of Chi­nese cadre fraud.

Craig Tin­dale is the Vice Pres­i­dent of the Cen­tre for Eco­nom­ic Sta­bil­i­ty, Pro­fes­sor Steve Keen’s non-prof­it research ini­tia­tive.

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About Craig Tindale

CEO in the software and technology industry qualifications economics and computer sciences well read on Minksy, Marx, Fisher , Schumpeter , Veber and dozens of of others