Investing in China unmasked
The transformation of China is a global event without parallel. In August, just nine years after the country joined the World Trade Organisation, China triumphantly became the world's second-largest economy.
In an uncertain world, one certainty is that its rate of economic expansion will continue to outstrip that of the West.
Yet this economic powerhouse, the lifeblood for one fifth of humanity, remains an emerging market, while the Chinese population has an annual per capita income of less than $1,000 (£640).
For investors, the key consideration in emerging markets is politics. They should be mindful that Beijing doesn't play its political hand close to its chest but behind its back.
To consider, for even a millisecond, that Rupert Murdoch might be easily duped, stretches the imagination. However, at a small private dinner in the 1990s, the media baron rather naïvely revealed that he had yet to meet a Communist during his visits to China.
Murdoch, who recently turned his back on the country, has been far from alone in misinterpreting the situation there.
Most Western businesspeople, and many fund managers, fail to fully recognise the reality of Chinese communism when they make deals with, or invest in, a Chinese company.
The country is awash with money, hope and consumer products. And there is an unmistakable swagger in the step of a nation on the up. It's easy for Westerners to overlook the fact that China is a one-party state with a command economy.
The grip of communism
To outsiders, the party has such a low profile that it is hardly visible. Westerners may find themselves in a room full of local businessmen ready to sign and shake hands on a deal, but it is the party official, anonymous in the corner, who wields real power.
"The party is like God. He is everywhere. You just can't see him." These words, from a Beijing professor, set the tone for a powerful and important book on China, The party: The Secret World of China's Communist Rulers.
Its author, Richard McGregor, was formerly Beijing bureau chief for the Financial Times. McGregor has uncovered fascinating details never published before.
The book offers a riveting and unprecedented glimpse into the reality of Communist China.
What does it mean to say China is a Communist state? Chen Yuan, president of China Development Bank, replies: "We are the Communist party and we will decide what communism means."
China, McGregor reveals, is run by 300 people, a collective known as the Central Committee of the Communist party of China.
Top of the heap is the all-powerful, nine-strong standing committee, headed by the most influential man in the land, Hu Jintao, the outgoing general secretary.
Outside China, he is effectively president and is "a familiar face, if not a familiar personality", says McGregor. Between the standing committee and the central committee lies the 25-strong politburo.
To Western observers, Chinese communism seems enlightened, benign and, now that the horrors of the Mao Tse-Tung era have faded from memory in the West, almost fit for purpose from a business point of view.
Underneath the surface, however, says McGregor, the Chinese model is Leninist.
The party has 90,000 cells in the army alone, one person for every 25 of the army's 2.3 million personnel. Every company of importance has its own committee and ultimate control rests with the party secretary of that committee.
To get ahead, companies need a 'red cap' or state endorsement. McGregor uses a graphic image of the red telephones that sit on desks in the top 300 companies to make his point. Part of a secure network to the top, if one rings, a Chinese company jumps.
McGregor describes how a judge who questioned the party's interference in a legal case was told by an official: "You call it interference. We call it leadership." The same mentality applies in the corporate sector.
Many people in the West associate the extravagances they see in China and the hundreds of new billionaires they read about with the private sector. But this is a mistake.
The private sector is miniscule and, as McGregor tells Money Observer, it has a lot of trouble accessing capital. "They have to self-finance from profits," he says.
In his book, McGregor says the party's distrust of the private sector was not about money or the contradiction between individual wealth and the official Marxist and Maoist pantheons.
"The real threat for the party was the danger that the foreign and private sector might become a political rival."
The uneasy alliance
However, an unprecedented partnership between a Communist party and a capitalist business holds. It remains an uneasy alliance, but one that has turned more than a century of conventional wisdom on its head.
"A broad consensus has now developed at the top of the party that, far from harming socialism, entrepreneurs, properly managed and leashed to the state, are the key to saving it."
McGregor doesn't subscribe to the view that China's massive stimulus package, and the inflationary consequences, will throw the broad economy off course.
"Urbanisation is still growing and it has some way to go. The economy will grow at between seven and 8% a year for the next five, and possibly 10, years, but that is not the real story. The present model has to change. It can't last, and that is a worry," he says.
He suspects that party policy will leave the currency unchanged against the dollar, so as not to tamper with the export market. McGregor believes China has no alternative but to keep buying US Treasury bonds - vendor financing, in effect.
He says: "They have a poor view of the euro, and the yen is not considered stable. What else can they buy?" Weakness in the dollar, however, is not taken lightly. "The politics of it is potentially incendiary,' he says.
"It is a pressure point and it won't go away. The US is in a greater funk: the [renminbi revaluation] policy conflicts with the China interests of US companies."
McGregor thinks the main challenges facing the party in the short term are internal. "Tibet and Xingjian [the Muslim province] are running sores," he says.
Sustaining water supplies to service massive economic growth and protecting the environment are also a concern. He adds: "There is always a problem with new or existing diseases. The country is a great incubator for disease."
McGregor says that, since the recent financial crisis, the regime is getting "cockier".
He points out: "The Western brand is damaged. The Iraq war has shown that the US engages in torture. It can hardly accuse China of the same. China has also got through every major financial crisis since the 1990s, while the US is still suffering from the last crisis. And China is the master of US reserves."
McGregor's book does not cover the post-1997 handover of Hong Kong to China by the UK. But he says the party operates underground there. "It will not even declare its existence."
Beijing bling and Shanghai flash seem to be indicative of deep corruption in China. But, as McGregor points out, corrupt regimes can last a long time.
He writes: "The Chinese officials who do get arrested for graft generally fall into one of two categories, sometimes both.
They are the losers in the political struggles or their corruption becomes so outrageous that it embarrasses the system and jeopardises the game for everybody else.
"Corruption in China seems to operate more like a transaction tax that distributes ill-gotten gains among the ruling class. In that respect, it becomes the glue that keeps the system together."?
The party: The Secret World of China's Communist Rulers, by Richard McGregor, is published by Allen Lane, £25.
This article was originally published in Money Observer - Moneywise's sister publication - in October 2010
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.