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, Sina.com, 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.

Twit­ter @ctindale

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
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  • tok­sira1

    None of this is sur­pris­ing any­one who spent time in Hong Kong and the PRC knows all this. I new Part­ners in the big firms who took early retire­ment as they just did’nt want to sign off on main­land accounts any­more.

  • imper­ma­nence

    The results of putting large amounts of other people’s assets [OPA] in the com­pany of par­a­sitic groups [PG] (e.g., banks, gov­ern­ments, what-have-you) is not so hard to fig­ure out.

    The for­mula is as fol­lows:

    OPA + PG = 0

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