Pay No Attention to That Totalitarian State Behind The Curtain!

The world watches as China's journalists start chafing under the yolk of party censorship… and The Party wishes they weren't

We laowai tend to get into a lather whenever any kind of protest movement in China picks up steam, or whenever something going on here starts to penetrate into the front pages of the major dailies in the west or into the A block on nightly newscasts.

As such, the China expat Twittersphere has been all abuzz this week with the now well-documented goings-on down in Guangzhou at the offices of The Southern Weekly. I won’t re-hash what's been happening in this space since there has been excellent, extensive and exhaustive coverage of the events elsewhere (check out this, this and this for great summaries), but suffice to say, posts have flying around from every corner- from overseas looky-loos, local expats, pundits and journalists, including a friend, Jonah Kessel, who was on the ground on Wednesday documenting the fairly quiet gathering for The New York Times.

But yesterday things got more riveting when the police finally decided to get involved and put an end to the protests. Mark Mackinnon, the Beijing-based correspondent for Canada's Globe and Mail newspaper, was on the edge of the crowd as the cops closed in and he sent out a series of updates to Twitter, letting people know what was going on in near real time.

When the police moved in, he was able to post photos, documenting the arrests.

What makes his posts even more remarkable is that the police knew that he was there and didn't remove him from the scene or prevent him from reporting. Just before things got serious he posted these notes about getting stopped by security officials.

With texting, social media, VPNs and e-mail-based photo sharing services available to everybody, it's very, very difficult for the government here to keep a lid on anything that happens, whether it be a small protest or a train derailment. And it's next to impossible to do it if a western reporter happens to be there. Short of arresting and expelling all western journalists, the Chinese government just has to deal with incidents like this getting out into the public sphere. And that's a very new phenomenon for them.

Keeping up apperances

One thing that westerns need to keep in mind whenever they read about how secretive the government is and the lack of press freedom (especially when they read about people protesting against press independence), is that the concept of "face", or a positive public image, is very, very important to Chinese people culturally. Maintaining good "face" helps one's social status. It's a big reason why nouveau riche Chinese are so luxury label obsessed.

This idea of "face" translates upward. If the government has a good image, then, by extension, the whole country has a good image. How things appear is just as important here as facts behind the scenes. Sometimes it's even more important. (Check out these comments that Jackie Chan made to the Chinese media yesterday for a great example of how this works.)

So if this is true, and if strict government control over the flow of information is not only the norm but a cultural and political imperative, then reporting like this week's, and the kind that's been going on for the past year, has got to be particularly galling to the country's ruling elite.

Example after example can be seen where the Powers That Be have let slide Chinese citizens' exposure and criticisms of the corrupt practices of local officials. There are historical and cultural precedents for tolerating this kind of venting. It's an obvious move by the central government (as it was by the governments of dynasties past) to give the people an outlet through which to channel their anger and frustrations. When a local official is then sacked or prosecuted, the higher authorities in Beijing look like competent heroes looking out for the little guy instead of the corrupt enablers that they are.

But when chatter starts to touch on the practices and predilections of the highest level officials and/or leaders of the most powerful political cadres, the talk is snuffed out in short order via censorship, or "Harmonization", on online forums and traditional media blackouts. Good "face" is maintained.

Enter the foreign press. While they’ve been doing a good job for several years, it's in the last 9 months that Beijing-based western correspondents have begun to not only shine, but to start making the people at the top extremely uncomfortable.

2012 saw more major websites banned and more journalists expelled than at any time in recent memory. Al Jazeera was first when its correspondent, Melissa Chan, got expelled for undisclosed reasons (though many believe that her reporting on China's notorious "Black Prisons", combined with a critical Al Jazeera documentary on Chinese labor camps are what did her in), and the company has not been allowed to send in a replacement reporter since. Bloomberg was next when its website was blocked from servers in China in retaliation for its expose on the wealth of incoming President Xi Jinping. Next up was the New York Times, who just 2 months after launching their Chinese-language site, saw their website blocked for the first time since 2001 after they published an exhaustive report on the riches gained b the family of outgoing Prime Minister Wen Jiabao.

Blocking websites will only get you so far. More and more Chinese can easily get around the blocks. (China was Facebook's #1 country in terms of growth last year, even though the site is banned.) Domestic social media sites are censored, but not in real time and not completely.

The bottom line is that you simply can’t be the #2 economy on the planet (soon to be #1) and NOT allow an international press presence. Information is currency in today's world and if there's a lack of a data flow then people simply won’t do business with you. China's leaders know this.

So what to do? As of right now the Chinese government's policies towards press freedom and freedom of speech in general has got them looking like Tom Thumb sticking various fingers in a leaky dyke. Unauthorized information comes out fast and furious these days and it's nigh impossible to stop it.

Be careful what you wish for

What we're seeing are the consequences of a shift in media policy that began back in 2000-2001. China was bidding for the Olympic Games and they were making conscious decisions to open up more. The New York Times was unblocked in China and more reporters were allowed in and given greater and greater freedom to move around and report on what they saw.

Bidding for the Games in the first place (and the World Expo in 2010) was seen as China's "coming out" party. Domestically it was a source of pride and a marker in history. This would be the point when China stepped back onto the world stage and reclaimed its role as a central power after almost 200 years of living in the shadow of the west.

China got all that it wanted. Beijing became a veritable hive of foreign bureaus from every conceivable media outlet (The Hollywood Reporter even had a bureau here for a while). The world sat up and started paying attention. In a big way. After the Olympics, China emerged as one of the few bright spots when the world financial crisis happened, shining the spotlight even brighter on what was happening here, as people all over the world gazed with envy at their success and searched for things that they could emulate in their own countries.

This intense attention has only grown as the press has become more emboldened here and the government's reactions to what we in the west would consider normal reporting on the levers of power have seemed so overboard as to be laughable. Instead of preserving "face" their reactions are making them lose it.

So what next?

China can not simply imprison or expel everybody who writes unflattering things. And western journalists can not sit idly by and let things go unreported because, unlike their Chinese colleagues, they not only have an outlet for reporting what they see, but they have an imperative (i.e. demanding editors and a ravenous-for-news public). Too many people have access to too many avenues of communication for that to be feasible. And western reporters have found many willing sources of information. People will talk to them (though not at the highest levels). Weibo conversations can not be censored fast enough before they are captured and re-printed on sites outside of China.

The Chinese government craved the spotlight. It wanted to showcase all of its accomplishments, of which it has many to be proud of. But what the leadership was either unprepared for, or simply did not imagine would happen, is that the spotlight that is now on them has started to expose the seedy underbelly of their operations.

Up until recently they've been fighting back in the way that they always have, by exerting more and more control. The new administration isn’t quite installed yet, and even when it is, most of the members of the Standing Committee will be old hands left over from the previous cadre, but I would not be surprised if over the next year or two you start to see some loosening of the reigns. I think that China will focus more on internal information controls and worry less about what foreign reporters are doing. As a younger generation moves up within the party's ranks, a generation who has grown up fully exposed to the west, you'll even start to see a more sophisticated media strategy evolve- one that doesn’t depend so much on the crude bludgeon of walled-off websites and expelling journalists.

China's Impending Foreign Direct Investment Armageddon, Part 2

Shifting the financial center of gravity from west to east

Last time, I bought you up to speed on what's been going on with the brouhaha between China and the US over Chinese companies that are listed on US markets. It's clear that we're on the verge of what could be a pretty major confrontation that could shift the focus of China's capital markets from the US back to China.

There are other, smaller legal skirmishes going on, like the dust-up between VisionChina Media and the Supreme Court of New York. The court has entered a judgment against them for $60 million, but VisionChina refuses to transfer any funds from China to pay the fine, saying that Chinese law does not allow it to. The court has now held them in contempt. Will warrants be issued for the arrest of executives? Will they be kicked out of the market? It's hard to say.

Nobody is quite sure what's coming next in this fight. Both sides have legitimate claims against the other. The US says that if you're going to use our markets to raise capital, then you've got to play by our accounting and disclosure rules. China says that you can’t send US government officials into China to impose US law on Chinese citizens. So who's right?

Well, both sides are right, and both sides are wrong… which is why we're at loggerheads.

I'm pretty pessimistic about all of this in the short term. I heard a great point brought up on a recent Sinica podcast about this issue. Basically, both sides are kind of spoiling for a fight. And since they can’t safely engage with each other in any other area without risking serious hostilities or dramatic diplomatic consequences, they may be willing to refuse to come to any kind of agreement here.

If that happens, you'll see a full-on retreat from the US by Chinese companies, which will result in billions of dollars of value being wiped off of the ledgers of US markets. That's not a good thing. Those companies will then start looking for new places to trade their shares. Where will they go? Reputable companies like Baidu don’t want anything to do with the Shanghai or Shenzhen stock exchanges. They're so corrupt as to be laughable. And places like London and Singapore will have the same kind of sovereignty issues to deal with. The logical thing for China to do is to facilitate the move of companies from US markets to Hong Kong.

But that's not really as easy as it sounds. There are currently questions in Hong Kong about the accounting practices of some of the mainland China-based companies that are already listed there. Hong Kong has a brand to protect, too. They certainly don't want to ruin the good thing that they've got going by infecting their markets with a bunch of unreliable companies whose numbers can’t be trusted.

If the Hong Kong markets were to develop an acceptable processes for handling mainland China-based companies, you could see an avalanche of IPOs there. There is a huge backlog of companies on the mainland who would love to go public, but the corrupt and inefficient processes in China mean that only a fraction of them get to list. And after they do, trading is severely suspect and there isn’t much capital to be had. If they could be given a roadmap to follow that would let them access international capital markets through Hong Kong they'd jump at the chance.

If you saw more companies make the leap to Hong Kong, it could put even more pressure on China to float its currency, or at least ease their controls and provide some more outlets for moving it across borders. This would be an unequivocally good thing for the US. The Yuan would rise, more Chinese would be able to buy US exports and there would be less incentive for US-based companies to move their manufacturing here. (Though that process is already well in motion for other reasons.)

As pessimistic as I am about the short term prospects for a deal between the US and China, in the long term I think that this confrontation will end up being a good thing. As I first said 18 months ago, the US forcing Chinese companies to adopt western accounting practices, and China better policing its markets, can only be a positive for the world's economy. Giving more people access to investment opportunities in China will help to not only open the market even further, but it will also help to develop China's business community in ways that will be very beneficial to the burgeoning middle class here. Who knows, maybe a mass of Hong Kong listings from Chinese companies might even lead to some truly public, accessible investment vehicles that middle class Chinese could take advantage of. That would have a tremendously positive effect on housing pricess, upward mobility and inflationary pressures.

Time will tell. Stay tuned!

China's Impending Foreign Direct Investment Armageddon, Part 1

The biggest China story for 2013 that you're not hearing about

There’s a showdown brewing that could presage a historic shift in world capital markets, but because of the western press' preoccupation with the US presidential election and China’s change in leadership it hasn't garnered much coverage: The looming "fiscal cliff" faced by Chinese companies that are traded on US stock markets and the investors who have bought in to them.

Case in point, check out this post from the Council on Foreign relations' website. In it, they list the "Changes and Challenges for China in 2013", but nowhere is this issue mentioned. This is, I think, a tragic oversight, because what’s going on could have more real word effects on people’s lives (in China, anyway) than the hubbub over the South China Sea.

It's a complex situation that is wrapped up in legal and political knots on both sides of the Pacific, so I'm going to break this post into two parts in order to keep it readable. First up, a primer:

Chinese companies have been listing themselves in US markets for years. Right now, shares of just over 200 companies are being traded on the New York Stock Exchange, the NADAQ and the AMEX markets. China has the largest number of companies of any country outside of the US trading in our markets today.

There are lots of reasons why a company might want to trade on a US stock market, but in China the most common are 1) prestige, which allows companies to compete for more international contracts; and 2) access to capital, which is in short supply in China since Chinese banks, which are state-owned, make almost all of their loans to other state-owned companies. Money from foreign markets/investors, or “Foreign Direct Investment” has been one of the few sources of capital that small- and medium-sized businesses have had access to and it has been one of the main drivers of China’s economic growth over the past decade.

These issues, coupled with the difficulties conducting transactions in Yuan (due to China's strict currency controls) led to a boom of listings by China-based companies on US markets from 2008-2011.

Many of these companies’ listings were done through “reverse mergers”, which are pretty shady deals. Basically, a Chinese business buys out a bankrupt or otherwise defunct company in the US that still has a valid stock ticker and then just starts trading under that ticker. This method is much easier and faster than the normal process, which requires all sorts of regulatory hurdle-jumping and accounting disclosures.

Of course, these quickie listings don’t allow for the kind of weeding out of companies with secretive or blatantly fraudulent accounting practices. In 2011, a series of reports were published by investment research firms that exposed many Chinese companies' corrupt dealings and falsified disclosures. Investigations by the US Securities and Exchange Commission (SEC) were launched and delistings ensued. As a result, we've see a massive devaluation of Chinese companies in US markets since then. This has not only led to many companies closing down or going private, but it has wiped out billions of dollars of investors' wealth.

This drama has been playing out for almost two years and you can read my August 2011 post about the reasons behind the reverse merger boom and bust here. In it, I broke down the phenomenon and speculated that even though you'd see lots of companies fold, it could turn out to be a good thing for China's economy.

[Companies that survive will] set the stage for a new era of Chinese corporate governance. In the end, it will be the companies that decide to adhere to the rules of the Western game that will be successful. Their success will breed imitators here (it's what the Chinese do best, after all) and just as Big Macs and blue jeans helped to conquer to Soviet Union, the Chinese's own drive to get rich and access Western markets will drive them ever further towards our way of doing business.

While I still hold to that idea, it appears that the timing of this evolution could be significantly delayed, and/or the context of it radically altered. The investigations that the SEC launched have since turned into lawsuits, with the US government seeking court orders against US-based accounting firms and their Chinese clients for internal accounting documents. In effect, they're trying to apply US law to companies that are based in China.

The Chinese government isn't having any of it. Saying that any disclosures to US regulators would be a violation of their sovereignty, they're telling the SEC that not only can they not see Chinese bank/corporate documents, but that any accounting firm or corporation based in China that hands any of these documents over could be subject to the State Secrets Act. Violation of that law carries penalties like life in prison or the death sentence.

Given those consequences, its understandable why US accounting firms are loathe to demand that their Chinese affiliates (which are, buy law, at least 50% owned by a Chinese concern) hand over anything. And so… a stalemate.

Both countries have a legitimate beef with the other. On the US side, the government has a vested interest in maintaining the integrity of its capital markets. As far as they're concerned, Chinese companies have chosen to sell their shares in the US and they should follow US disclosure and reporting requirements. On the China side, the government doesn’t see any reason why they should subject any of their citizens or corporations to the laws of a foreign country. In their minds, Chinese disclosure and reporting laws should suffice for Chinese companies.

This pissing match between the SEC and the Chinese government reached its final stages in early December when the SEC went to federal court to compel the US-based accounting firms to give regulators access to the accounting documents of the Chinese companies that they're investigating.

The result of this suit will have a lot of very important consequences. And they'll manifest themselves very soon. The case, by law, must be acted upon by November 2013. This means that the SEC must come to some sort of arrangement, or the Chinese branches of the accounting firms must hand over their internal documents by then, possibly in violation of Chinese law, or… well, nobody is quite sure what happens after that.

In part 2 I'll get into what I think will go down and what the benefits/concequences to China and the US might be.