China's Potemkin Stock Market
By Staff News & Analysis - June 22, 2010

China has become the world's third largest stock market, the country's securities regulator said. According to the China Securities Regulatory Commission, the total market value of the Shanghai and Shenzhen markets hit 3.07 trillion dollars as of the end of May. The total market value so far was up 393.76 percent compared to the 2003 level, Xinhua news agency reports. The United States has two of the top three exchanges based on market value. The New York Stock Exchange (NYSE) is the largest exchange by far with a market value of $9.57 trillion, while NASDAQ exchange has a market value of $2.77 trillion. – Economic Times

Dominant Social Theme: The brilliance of China …

Free-Market Analysis: The Chinese miracle plays on. The yuan pushes up against the dollar now that Chinese leaders are letting the yuan float. Chinese stock markets are soaring. Meanwhile, Senator Joseph Lieberman has launched legislation to specifically grant the Obama administration the power to "turn off" the Internet in case of a national emergency. "Right now China, the government, can disconnect parts of its Internet in case of war and we need to have that here too," Lieberman reportedly said during a CNN interview. China – the new touchstone. China – the new point of reference. China the lodestar – around which all other western democracies revolve.

Yes, the China meme is in full cry. Dominant social theme: "The Chinese government may be a tad repressive but so long as capitalism functions on the streets, who can complain?" It is actually the South American model in our view. The government controls the meaningful elements of society – its largest industrial and financial companies – while competition is restricted to the street where peddlers engage in cutthroat competition to sell cell phones at ever-cheaper prices.

This is the model, in fact, that the leadership of Western societies want to emulate in fact. One can smell it in the "austerity" being preached in Europe and, generally, in the collapsing fiat currencies around the world. How do these societies function? At the very top they are run by hugely monied families and individuals. These are the "owners." At the next level down are the accountants, valued for their ability to manipulate numbers in a way that is both legal and lucrative. Next on the pecking order are lawyers. Lawyers are less valuable than accountants because they do not work directly with money. After lawyers come managers. Managers handle and organize actual products. They are not nearly so important as accountants and lawyers in this mercantilist model. Finally, at the bottom are the "creative types" and workers, those who actually produce.

One can see the inversion of reality in this pecking order. In a republican society, where individuals work entrepreneurially or in flexible, interlinked groups, the actual output, the result, is what counts. In the corporate or multinational model, what counts is not the product or service so much as the handling of resources, specifically monetary resources. In fact, absent the legal fiction that invented corporations and absent the rest of the paraphernalia of the modern regulatory democracy, there is little doubt that multinationals would be considerably reduced in size and power.

The Chinese model, if we can call it that, is merely a more corporatized-cum-statist version of the West's regulatory democracy. If one projects the trends of the current Western status quo, one might be tempted to conclude that China is the destination. Likewise, if China continues to "evolve," then its destination is irredeemably that of Western Europe or the United States. There is not that much separating these three "super states" – shades of George Orwell, of course.

But for now, China is not the United States or the European Union (what's left of it). China is still very much in the development stage. Its democratic institutions are evolving. Savvy observers have suggested that much of China's segmented corporate universe is actually controlled top-down and that major decisions are made by the small handful of old men who run China and the powerful interest groups (including the military) that stand behind them.

The same might be said for China's financial institutions. The Chinese central bank is obviously an extension of the policy of the Chinese communist party. But what is not so well known is that the Chinese stock markets – now the third largest in aggregate in the world – are likely similarly controlled. A documentary some years ago followed two Chinese female investors that had done very well in the market and basically concluded that their success derived from following comments made by the Chinese government. If they could identify a company that the Chinese leaders supported, they would invest in it with commensurate positive results.

In fact, as we have stated many times before in these modest pages, every part of China's most important industrial and financial segments are controlled by the state, or by the small coterie that runs the state. We cannot prove this of course, but we can make observations based upon what we have read and observed. The same group that ran China 50 years ago is still in power today. To believe they have voluntarily implemented a free-market system at the top of Chinese society is foolish. They have not. Thus it is in China, we see a system of Potemkin finance. Here's how Wikipedia defines a Potemkin village:

Potemkin villages or Potyomkin villages is a fixed phrase based on a historical myth. According to the myth, there were fake settlements purportedly erected at the direction of Russian minister Grigory Potyomkin to fool Empress Catherine II during her visit to Crimea in 1787. According to this story, Potyomkin, who led the Crimean military campaign, had hollow facades of villages constructed along the desolate banks of the Dnieper River in order to impress the monarch and her travel party with the value of her new conquests, thus enhancing his standing in the empress' eyes …

"Potemkin village" has frequently been used to describe the attempts of the Soviet government to fool foreign visitors. The government would take such visitors, who were often already sympathetic to socialism or communism, to select villages, factories, schools, stores, or neighborhoods and present them as if they were typical, rather than exceptional. Given the strict limitations on the movement of foreigners in the USSR, it was often impossible for these visitors to see any other examples.

If China can be said to have broken new ground, it is in the way the old men of the Politbureau have connived to reshape the breadth of the concept. In China today, we would argue, the Potemkin Village has expanded from a physical manifestation to a metaphorical or even metaphysical one. The entire larger Chinese economy is a kind of Potemkin Village, we think, in which every corporate and financial facet appears, at least to a degree, independent of the larger centralized entity – but is not.

This is entirely in line with Chinese culture, its emphasis on Confucianism and obedience to family and state. China, despite its entrepreneurial vitality, is still a very regimented society. These two conditions can certainly exist simultaneously. That does not mean they will remain in balance forever, however. In fact, we would argue it is a tenuous balance at best, which is yet one more reason to retain skepticism when it comes to evaluating the current Chinese model.

It is not entirely fair to single China out, for the Chinese system is in many ways not much different than that of the EU or the United States. But we will continue to insist that the current success of this Great Dragon is evidently and obviously the result of extreme inflationary prodding. The Chinese central bank has injected over a trillion recently into the economy with more coming. At the same time the economy is starting to experience wage push as more Chinese have jobs and are dissatisfied with the starvation wages they receive.

Finally, the floating of the yuan is also, in probability, an indicator of the severity of the problem of inflation, especially of price-inflation, for a floating yuan will inevitably rise against other currencies and provide a counterweight to inflation. A floating yuan is an admission of the intractable problem of price-inflation, not merely a surrender to Western pressures.

After Thoughts

China has come a long way in 50 years. It is truly a miracle of sorts and has provided much in the way of opportunities for its ambitious, disciplines and hard-working citizens. But to assume that China is any way a free, or non-controlled society is as naïve, at this point, as assuming that America itself is society fully based on free-market principles. The Leviathan is alive and well in the West and certainly in China. Those who believe in the idea of a libertarian, resurgent China are falling for a kind of "myth-making" in our opinion. Heck, call it a promotion.

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